No Surprises

The Fed meeting in Jackson Hole continues as this is written, but Chair Powell’s comments on Friday morning, the ‘highlight’ of the confab, were no surprise. Chair Powell reiterated that the inflation target is 2%, not 3% as some on Wall St. have speculated, and with rates at or near restrictive territory, any changes in direction will be a function of how the data rolls in. Powell says the Committee will ‘proceed carefully’. Finally, he once again cautioned against expecting rate cuts anytime soon. Here is our simple interpretation of his comments:

  • If the economy continues to re-accelerate, look for more rate hikes before year end
  • If the economy rolls over quickly, rate cuts will follow
  • If the economic porridge is just right, the Goldilocks scenario is rates won’t rise, but will remain high for a period of time.

Of course, the third option is the Fed’s desired option and until that mark is clearly missed, it will remain Powell’s verbal target in any speech. But maybe we are focusing on the wrong comment. The one thing that the Fed has consistently said, and consistently projected, is that a slowdown of the economy was ‘necessary’ to reach their inflation targets and that did not change on Friday. While there are some economic cracks appearing around the edges, we certainly are not yet seeing any solid evidence of a slowdown, and that would make a couple of more rate hikes the more likely scenario.

Who’s Buying That Story?

The Treasury market is. The consensus appears to be that the improving economic data will force the Fed to raise rates higher still. This has resulted in a bear steepening of the Treasury yield curve. (A bear steepening is when long rates rise and short rates do not; a bullish steepening, which is more typical at the start of a recession, occurs when short rates decline and long rates do not. Note: when rates decline, bond prices go up.) As a corollary, the timing for eventual rate decreases is getting pushed further into the future. Bond market action is very clear: more rate hikes are coming, and that should theoretically pressure stock prices.

The stock market isn’t buying the bond markets view. The stock market has taken a look at the same economic data and concluded that we may be headed toward a ‘no landing’ scenario rather than a ‘soft landing’ scenario. (The no landing scenario would suggest that the economy continues to plow forward, higher rates be damned). Strong growth should be supportive of equity valuations. Although the market is a bit stretched from the recent AI rally, the consensus opinion remains bullish.

Somebody is right and somebody is wrong. How this disparity hashes out will likely determine how the last four months of the year develop.


Housing Market Mayhem

As of Thursday, the average 30 year fixed mortgage rate reached 7.53%, a level last seen in 2001. The rise in mortgage rates has limited the number of existing homes available for sale as existing homeowners are reticent to give up their low-rate mortgages. One might think that these high mortgage rates are driving prices down, but that would be incorrect! The broad unwillingness to sell (blue line below) has crimped the supply of existing homes available for sale. The result is that sellers still have the advantage and prices have remained high.

One might also expect new home sales to be down due to high rates, but that would also be incorrect. With so few existing homes for sale, the market is gravitating to new homes and sales have remained reasonably strong (orange line). New home builders are making some price concessions, but deals are getting done at reasonable prices and the homebuilding stocks have had an unexpectedly strong run this year.

As shown on the chart, the result is a trend that breaks all the old rules. New and existing home sales typically move in the same direction, but not now and no one knows how long the divergence can last. It is yet another example of how disruptive very low rates can be when in place for a very long time. Normalizing this and many other markets will not come easy.

What We’re Reading

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By: thinkhouse