It’s been something of an aimless chop back and forth for the markets the last few days. Last week both short-term and long-term rates spiked higher and stocks sold off. This week rate volatility persisted (the 10-year briefly trading above 4% for the first time since October), but stocks rallied. I could try and pin a reason on the equity rally, but it sure seemed like a move on no real news. More motivated buyers than sellers?
The move in 2-year bond yields really tells the story of where perceptions are today.
As you can see, rates in both the U.S. and Germany have pushed to new highs. It’s not too much of an exaggeration to say these are probably the most important financial market benchmarks at the moment. Shorter-term yields reflect a few things: 1) the outlook for the global economy, 2) the outlook for inflation, 3) what investors think central banks will do in response to 1) and 2).
The recent spike higher is telling us the following.
Economic Activity Might be Accelerating….
First, growth is proving surprisingly resilient. There’s very little talk of recession risks at the moment. Take the services sector. Friday’s report showed a rebound in activity, with a big spike higher in new orders (blue line).
Or housing. Pending home sales really surprised on the upside. Apparently the recent tick lower in mortgage rates boosted activity in January.
All this matters because sentiment had become very bearish on growth at the end of last year. Once again, the magazine indicator nailed the low. Fortune ran a recession special just at the point growth expectations for 2023 hit the low.
…Inflation is Proving to be Sticky…
Can a financial concept take on tactile properties? Sticky? I guess it gets across the idea that the rate of change in inflation isn’t coming down much. Last week we learned that monthly inflation actually picked up a bit in January. That wasn’t the plan at the beginning of the year.
…Means Higher for Longer
What this then all means in practice is that there’s still pressure on global central banks to tighten monetary conditions and keep them there for longer than originally expected. The change in expectations in just the last month is pretty dramatic. The blue line below shows where rate expectations were back on February 2nd. A peak Fed Funds rate of roughly 4.8% with rate cuts starting in the 3rd quarter. Now the peak is getting close to 5.5% with no cuts by year-end.
But of course, all of this is interrelated. Higher rate expectations is feeding through into higher bond yields, which is once again pushing mortgage rates above 7%.
So, housing will probably once again become a drag on growth in March or April after being a tailwind at the start of the year. Back and forth, rinse and repeat. I’m not sure anyone would be surprised that this churn continues for another few months.
Finally, I think what we are really finding out is that the real economy is proving to be much more insulated from interest rate increases than it is has historically. After all, a 7% mortgage rate isn’t doing much to roll over housing outside of the most overvalued markets. The chart from Goldman captures the reason for the resiliency. 99% of current mortgages are below today’s rate, and most homeowners locked in at sub-3%.
It's a somewhat similar story in the corporate credit market. As a result, a 4.5% Fed Funds rate is proving to be less restrictive than originally thought. The Fed is searching for the right number – will it be 5%? Maybe 6%? We can’t quite be sure, but it’s likely the financial markets are much more sensitive to rates in today’s world than the real economy.
(Other) Charts We Found Interesting
- Speaking of sticky inflation, prices continue to percolate in Germany.
- Despite the increase in rates, the yield curve remains inverted, with short-term rates higher than long-term rates. The spread between the 10-year and 3-month remains near historic lows.
- Inverted curves are a global phenomenon.
- Why does this matter in real life? It can slow bank lending. After all, banks run on a model of borrowing short-term and lending long. If short rates stay higher than long rates for long, margins will come under pressure. There are growing signs of tightening credit standards (bottom panel).
5. A lot of money chased Cobalt prices in 2022 as a play on electric vehicles. This hurts.
- Close to a third of California’s electricity generation came from wind and solar last year.
- As of Tuesday, snow in the Sierras crossed 500 inches of snow for the season!! And there’s another few feet on the way this weekend.
- How Sierra snow levels compare to prior years. The most since at least the 1970-1971 season.
Have a good weekend.
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