Today the 10yr trades at 1.55% and has been stuck between 1.50 and 1.60%. Mortgage rates for the most part haven’t moved in almost two months. The market is however, reaching the boiling point of uncertainty as we approach the end of 2016 with the Fed Funds rate still unchanged for the entire year. In fact at the end of 2015 over 80% of the market expected the Fed to increase rates by at least 25bps before September of this year. Almost 50% thought the Fed would have raised rates twice this year already.
Every year the Federal Reserve Bank of Kansas City sponsors a symposium on important economic issues facing the US and world economies. The event is held in Jackson Hole, Wyoming and will include a speech by Janet Yellen on Friday August 26th. What should the market expect out of Jackson Hole? In short, they are expecting a lot. There has been a lot of hawkish (rates up) chatter since the last FOMC meeting. Vice Chair Fischer indicated recently that inflation and the labor market were close to the central bank’s targets, implying a September raise. San Francisco President John Williams, last week said, “in the context of a strong domestic economy with good momentum, it makes sense to get back to a pace of gradual rate increases, preferably sooner rather than later”. Additionally the minutes from the July FOMC meeting were released indicating a few members felt a hike “would soon be warranted”. These are the most hawkish comments we have heard from the Fed in a year.
If you recall, last year the Fed warned of an imminent rate change in September only to hike in December. Is this another telegraphed “warn in September and raise in December” by the Fed? A lot think so and I tend to agree. As of today the market pegs the odds of a September hike at 28%, November at 34% and December at 54%. Even with the hawkish Fed tone the market is only pricing in a ~50% chance of a higher Fed Funds rate this year. The Fed’s credibility is still in question.
So all eyes are on Jackson Hole. This is the first chance for the market to hear from Janet Yellen since the minutes were released and likely the last time the market hears from her before the September meeting. The market expects her to clarify some of the recent comments made by other Fed members and to assist the market in understanding the Fed’s perception of the economy today, both domestic and foreign.
I still advocate that the economy has serious headwinds with regards to inflation and structural headwinds due to the world economy. A 25bps increase to the Fed Funds rate will do very little to the US economy or mortgage rates for that matter but it would really depend on the message the Fed delivers. I would prefer (if they are going to) that the Fed raise rates in December with language of only 25-50bps for all of 2017. That should calm the markets enough to ingest the rate increase. All of this is predicated on soon to be available economic data. But first let’s see what happens in Jackson Hole. I expect Ms. Yellen will clarify the Fed’s positon and recent comments by certain members with language to suggest that a rate increase is imminent but still dependent upon data.