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The Elephant in the Room

February 28, 2022

Last Week in Review: The Elephant in the Room

Interest rates improved slightly this week in response to the Russian invasion of Ukraine. This story is evolving every moment and the current uncertainty is helping bonds and rates. Let’s discuss what this all means for our economy and the Federal Reserve’s actions.

1.) Safe-Haven Trade is On

When bad geopolitical events take place, like Russia attacking Ukraine, global funds seek the “safe-haven” of the US Dollar and Treasuries, with mortgage-backed securities (MBS) also seeing higher prices and lower yields.

All risk assets, like stocks and cryptocurrencies, are selling off with the proceeds being parked in cash and Treasuries.

We don’t know how long the Russia/Ukraine war will last and we can only hope and pray for limited human toll and relative containment. As the story evolves, from minute to minute, it will move the financial markets. If the story worsens, we should expect rates to continue to track at or better than current levels. However, any signs of improvement in the situation would unwind some of the safe-haven trade causing rates to move back up.

It is worth noting, at the time of this writing, the improvement in rates has been quite modest given the magnitude of negative sentiment and uncertainty surrounding the invasion.

Let’s hope the sanctions applied to Russia move the needle and help push the story in a positive direction.

2.) Further Pain at the Pump

Upon word of the invasion, oil prices hit $100 a barrel. This is awful for our economy. It will lead to another rise of gas at the pump and, just before the busy summer driving season. A Summer that is likely to be a bit more normal with Omicron and Covid moving behind us. There will be enormous pressure on our government to take measures to lower oil prices. If oil remains at or higher than current levels, it will hurt consumer spending which makes up two-thirds of our economy. Think about it – if people are putting more money in their tank or spending more to heat their home, it will come at the expense of other goods and services.

Oil is in everything, especially so in housing. It takes oil to build and deliver tons of materials. In the era where 7 out of 10 families are currently unable to qualify for a median-priced new home, sustained high oil will only exacerbate this problem.

Let’s hope our government has a solution to provide meaningful and sustained relief, or we could experience an economic slowdown with higher prices – the very definition of stagflation.

3.) Fed Uncertainty Escalates Further

The Fed entered 2022, much like it did back in 2018, with a hawkish tone and a desire to raise rates several times. Back in 2018, the Fed raised rates three times which slowed the economy and hurt consumer sentiment.

Presently, the backdrop has gotten rather bleak. Consumer Sentiment is presently at an 11-yr low, and this is not factoring in the Russia/Ukraine war and Oil at $100. Additionally, financial conditions have already tightened, and small business sentiment has declined. These are not conditions in which the Federal Reserve wants to, nor can, hike rates multiple times.

The probability of a .50% rate hike has gone from 100% to just .15% in the span of the week. So, the Fed will hike rates next month by .25% to help fight consumer inflation, which is running at 7.5%.

What will the Fed do later this year? Will inflation rise further and force the Fed to do more? Can the Fed really do more? These are all big unanswered questions that will not be figured out until time passes. Until then, expect high volatility and push/pull market action between a safe-haven trade (good for rates) and high inflation (bad for rates).

Bottom line: This new Russian/Ukraine war changes everything. If you are considering a refinance or purchase transaction, now is the time when there is a lot of uncertainty. Upon better days ahead, we should expect somewhat higher rates.

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