Delayed Tapering Means More Time for Buyers
Powell spoke on Friday at the Jackson Hole virtual FOMC (Federal Open Market Committee) meeting. He sees the taper starting by the end of the year, but says there’s “much ground to cover” before considering rate hikes stating that the “timing and pace of the taper is not a direct signal to timing of rate hikes”. He also stated that “substantial further progress” has been met for inflation and that there has been “clear progress toward maximum employment”. He maintained his stance that inflation is temporary and is found largely in a narrow group of goods and services impacted by the pandemic. This week’s delayed tapering means more time for buyers however, the opportunity window will be closing.
What does all that mean in English?
The Federal Reserve has two mandates.. maintaining maximum employment and keeping the price of goods stable… which is why Powell focuses on the monthly unemployment numbers, job growth, and the PCE (Personal Consumption Index).
To date, inflation has reached the 2% target that the Fed feels is an appropriate measurement. Up until August 2020, the target was well maintained at a consistent flat 2%, then the Fed shifted monetary policy and how they measure inflation from a level to an average of 2%. This change would allow inflation to run hotter than normal in order to support the labor market and broader economy. Also giving the Fed the ability to NOT raise rates when inflation first spiked upward. The Headline PCE came out Friday morning minutes before Powell spoke, showing an increase of .4% in July and year over year rising from 4% to 4.2%.. the hottest reading in 21 years.
So.. to Powell’s point… “substantial further progress” for inflation has been met. You think? His stance is not to worry though and not to take immediate action with rates as inflation is temporary. I believe there are prices that have gone up that will not come down. Containers, homes, cars.. how much of what we are paying will return to what it was pre-pandemic or will some of it stick like a snails trail? His point is that durable goods, which has seen almost zero growth in the last 20 years, has benefited from the pandemic with demand spiking for those “things” we could buy to fill our COVID Castles… since we could not have “experiences”.
I do not disagree.. services inflation is still below pre-pandemic levels and inflation for durable goods has way outrun their services counterpart. Once rates do start going up, the cost to borrow in order to buy these durable goods will increase and people will think twice before either spending the money or spending as much money. Rates impact inflation.. but letting inflation go too far expecting it to fall could have consequences that reset the “normal” price of things higher.
But what about employment? There has been “clear progress toward maximum employment”. There has indeed! We lost 30 million jobs at the beginning of the pandemic, there are currently 10.1 million job openings and 8.7 million potential workers looking for work. Based on a historical average of 4% unemployment, we currently have 6 million more unemployed than pre-pandemic.. 5 million of those in services. Job gains have also been strong for the last three months averaging 832,000 new jobs; 800,000 of those in services. Service activity coming back online solves the employment deficiency.
If August’s unemployment numbers (to be released the first Friday in September) shows significant job gains dropping unemployment from it’s current pandemic low of 5.4%; it would not surprise me if we see the Fed start tapering at the next FOMC meeting. There are only two meetings between now and Powell’s “end of the year”… September and November. Many of the other FOMC members are getting louder in their comments that tapering needs to happen sooner than later.
“…timing and pace of the taper is not a direct signal to timing of rate hikes”
Rate hikes? Tapering? Mortgage Rates?
The Fed right now is buying $40 billion in mortgaged back securities and $80 billion in treasuries every month. What is not being outwardly shared is that they are also repurchasing approximately $60 billion in reinvestments.. i.e. those mortgages that payoff via refi, sale or mortgage principle reduction. When those mortgages are paid, the Fed is currently reinvesting that money as well. This makes the Fed the biggest buyer of mortgage backed securities, creating more demand, restricting supply to other buyers and artificially keeping interest rates low.
When Powell said the timing and pace of the taper is not a direct signal to the timing of rate hikes, he is referring to the Fed Rate which now sits at 0. The Fed will start tapering soon.. that will push rates up as current liquidity levels dissipate and supply starts to level set with demand. He doesn’t have to raise the fed rate to make rates go up. But what he’s doing is separating the two as the fed rate going up will have it’s own economic impacts as it’s the rate banks can borrow from the Fed and then loan to other banks, businesses, and consumers.
The Stock Market and Rates Benefited
For the moment, both the stock market and mortgage rates benefited. With news of not tapering and more money flowing into the market, the Dow jumped 200 points, the S&P 500 hit another record high, and the 10Y Treasury dropped from 1.34 to 1.31. Stocks up, rates low.. opportunities continue to show themselves.
The 50 day moving average line for the 10Yr UST is about to cross below the 200 day average. This could mean that lower rates are in front of us. However the 200 day moving average line is moving upward which tells us this drop in rates is short term. Add to this the pressure of inflation and push towards tapering. Higher rates are coming, but this week’s move has delayed tapering & means buyers have more time. Time that has a pending expiration on it.
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