Fed pauses for a second time as interest nears peak

Fed pauses for a second time this past week and wisely so as it awaits more data to come out before the next FOMC in November.  CPI and employment data print take more centerstage than Fed statements for now. 

To continue in its inflation fight, Fed would have no choice but to continue its hawkish talk, especially so when it opted to hold the funds rate this time.  Its latest dot plots also suggested a “higher for longer” policy stance in 2024 with two rate cuts projected, instead of four earlier, to bring funds rate down to only 5.10 per cent by end of 2024. That rattled the stock market globally once more.

We tend to have a more contrarian view in this blog – whether Fed enacts another one or two more rate hikes to end off 2023, we think it is done with rate tightening.  In fact, SORA here in Singapore has already peaked out below 4 per cent, in the 3.60-3.80 per cent range-bound.  I will not be surprised Fed goes for another two more hikes as the starkest part in this Fed statement is how, notwithstanding 11 rounds of rate hikes going back to March 2022, GDP growth in 2023 for the U.S. has been revised up from initial 0.4 per cent to 2.3 per cent!  The strength of the consumer and the labor market has confounded most analysts and economists over the course of almost the entire 2023 thus far. To bring inflation back down to 2%, it would seem that Fed will somehow need to “break” the economy and going to the six-handle for fed funds might still be needed. I won’t rule that out yet.

Still, the story over here in Singapore is vastly different.  We get asked frequently now if mortgage fixed rates will continue its down trend since the start of the year when it peaked out at 4.25 per cent and run down steadily to 3.05 per cent now (for loans above $1.2m).  Will it go below 3 per cent soon?  I don’t have straight-out answer for you on that but I can tell you the next six to nine months until mid-2024 is going to get very interesting.

I am expecting 2024 to be a very different year when compared to 2023 in which we get surprise to the upside.  I will call 2024 the year of reversal when we might get surprise to the downside this time.  Many people forgot about the quantitative tightening (QT) ongoing right now where Fed, traditionally the biggest purchaser of treasuries, becomes the biggest seller over the months by offloading about US$60b worth of treasuries and US$35b worth of mortgage-backed securities every month since June 2022.  The Bloomberg chart below taken from St Louis Fed website shows how Fed has managed to shave off about US$1 trillion from its balance sheet which has ballooned to US$9 trillion just before the current QT II started.

All these treasuries sale by Fed has insidiously caused yields to stay stubbornly high about 4 per cent in recent months, especially for 2-year and 10-year yield, even with Fed pausing rate hikes on short-term rates.  Should 10-year yield continue to ratchet up and breaks the 5 per cent psychological level, I will not be surprised to see another leg down for stocks.

I am expecting 2024 to be a very different year when compared to 2023 in which we get surprise to the upside.  I will call 2024 the year of reversal when we might get surprise to the downside this time.

If Fed does break the economy, be it through continued QT on the long end or holding funds rate elevated at the short end, and cause China and the rest of the world to stall in their recovery, we might get interest rate going down fast in 2024.  This would in turn cause cap rates to fall, property valuations to go up, gearing ratios to come down for REITs with fierce price recovery, bank stocks to go down if GDP growth turns negative, more layoffs, etc.

Of course, we can’t be sure that’s the scenario 100%.  But it will be almost insane to think Fed can continue to hike interest rates going into 2024, when they are now projecting cuts.  It’s pretty apparent to everyone that Fed just needs to hold its gun and let monetary policy’s long and variable lags play itself out fully in 2024.  In other words, interest can only come down in 2024, if not flat.  Speak to our team of consultants here on what to do if your mortgage review is coming up in 2024 – a wrong move could prove costly in cycle-turning years.

If Fed does break the economy, be it through continued QT on the long end or holding funds rate elevated at the short end, and cause China and the rest of the world to stall in their recovery, we might get interest rate going down fast in 2024. 

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