us fed

Fed Has Spoken, So Has The Market

Due to rising US 10-year Treasury yields in recent weeks, this is one of the most important FOMC statement to watch this year.  And once again the Fed has spoken with the same conviction as before – not raising rates anytime soon.  But will the market believe?

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Judging from early response from financial markets as yields continue its climb and shot up above 1.70% after the FOMC, the market does not think so.

This is the big debate that’s been going on for some time ago – how long can the Fed hold on?  If yields continue to skid higher and cross into the 2.00-2.50% range before the year is over, surely it will be forcing the Fed’s hand at some point.

The key notion is that of inflation being transitory – a view that is maintained by Fed officials.  It will certainly rise up a little in the later part of the year especially with the new US stimulus cheques.  But Fed believe that this rise will not be sustainable and it would fall back by 2022.  The Fed’s unequivocal focus is on getting full employment back and in particular that 10m displaced from the workforce due to the pandemic.  Until data showing that job is done, the Fed has repeatedly put out its position that it will be willing to tolerate inflation overshooting 2% for a period of time.  But financial markets especially the bond market is having none of that.

What has all that got to do with your home loan interest rate?

tug of war between market and Fed

That tug-of-war between the Fed and the market when it comes to inflation and treasury yields will determine largely the trajectory of interest rates going forward.  The signal of a turn up in interest rates is when Fed starts to hike rates.

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Fed has acknowledged the strong economic data coming out from reopening and vaccination programme gathering speed in the US. It has revised up its forecast:

  • GDP for 2021 is now expected to hit 6.5% instead of the earlier 4.2%, before slipping to 3.3% and 2.2% in 2022 and 2023 respectively
  • Unemployment to fall to 4.5% by end of the year, instead of 5% in the earlier forecast in Dec.  This would further fall to 4.2% and 3.7% in the subsequent years
  • The all-important inflation metric used by the Fed – PCE (Personal Consumption Expenditure price index) is now expected to rise to 2.2% by end of the year, but would likely fall back to 2% in 2022 before rising slightly after that. 

Yet for now the Fed has maintained the Fed funds rate at near zero and vowed to continue its asset purchases at the same pace.  The biggest change in Fed’s policy is that it is now no longer pre-emptive but reactive to inflation pressure, opting to play the patient game.

It will be interesting to watch this continued tussle between the Fed and the market throughout much of this year and next.  At some point the Fed will relent. Already, more Fed officials in the 18-strong committee are voting for rate hikes according to their dot plot: Four instead of previously one official now voted for one rate hike in 2022, and seven instead of five voted for another hike in 2023.  A lot depends on the data coming out from the economy especially employment data.

In many ways we do face the same tussle here at MortgageWise advocating a patient approach in moving from floating to fixed rates – but the market is obsessed with and wants fixed rate now!

We say let’s not be pre-emptive but rather react only when Fed finally announces a rate hike be it in 2024 or earlier.   We can afford to wait.  

Just like how inflation pressure can be transitory says the Fed, any increase in interest rates can also be “transitory” and reverse downwards by 2022.  Has it ever happened? Yes, as recent as 2016 – A false start.  We will cover more on that in this blog.

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