The Fed sent the markets into a tizzy recently, finally admitting that inflation is now a serious problem and that there would likely be as many as THREE RATE HIKES in 2022.
The bond and mortgage-backed securities (MBS) markets reacted negatively, and every lender announced a series of mortgage interest rate increases as a result.
But, then after the markets fully digested all the news, interest rates came back (fell) and are holding relatively steady – if not lower in some cases.
So, the question remains why would rates not go up when the Fed announces potential rate increases?
Rate Hikes Fight Inflation
The main reason, according to many market-watchers like the folks at MBS Highway, is that the debt/bond markets see rate hikes as measures to counter inflation (a huge concern for bond investors because they do not want “negative real rates” where their yields are less than the rate of inflation – like we are seeing right now).
Anything that might slow inflation is great for bonds (both treasury and MBS), and what is good for bonds is good for rates (assuming “good” means falling).
Other reasons rates did not go up include the following:
- Fed Hikes Short-Term Rates Only. When the Fed announces rate hikes, it is referring to the Fed Funds Rate – which is a very short-term rate that banks charge each other for overnight borrowing. Short-term rate increases do not always directly affect 30-year rates.
- Rate Hikes Perceived As Inhibitors For Economic Growth. Over my 25-year career in mortgages, I have seen the rates go in both directions in response to announced rate increases by the Fed. This is because sometimes the markets see rate increases as something that will slow economic growth – which tends to push rates down. Other times, the markets apparently just take the Fed at its word and expect the Fed’s efforts to push up rates to be successful at all levels.
- Markets Expect Recession In Any Case. This is a factor that Jeff Snider of Alhambra Investments might give significant weight to, as he thinks we are in for a big recession in the near future and that bond markets are merely continuing to reflect that. This is because rates tend to fall during recessionary times in general.
- The Fed Can’t Raise Rates/Beholden To Stock Market. This is something the MBS Highway folks and many other market watchers allude to all the time. The Fed’s mandates are to supposedly “maximize employment and to stabilize prices,” but it effectively has a third mandate: to keep the stock market fat and happy – because it is politically unpalatable to see stocks tank. And something that often tanks stocks is higher interest rates. Hence, if and when the Fed actually does push through with rate hikes and stocks tank, many market watchers expect the Fed to quickly find an excuse to back off on its threatened rate-hikes. This may be the strongest factor of all. The Fed is in a pickle (can’t raise rates to fight inflation because stocks will likely tank) and most investors know that.
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