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Inside the Economy: The Fed and Interest Rates

By November 1, 2023No Comments

This week on “Inside the Economy”, we discuss an array of economic news. Consumer spending is still strong and retail sales continue to climb. Even as the Fed raises rates, the housing market has stayed strong, and unemployment remains low. What, if anything, will begin to slow or influence the Fed to lower rates? Tune in to learn more!

Key Takeaways:

        • Bond yields continue to rise
        • Oil prices rise again
        • Mortgage rates approach 8%

Full Transcript:
Welcome to another edition of Inside the Economy!

I’m Larry Howes. Thanks for joining me!

Topic this time, do you think the Fed is done raising interest rates? Is there a reason for them to be done raising interest rates? They’re going to meet this week, probably not going to raise rates. The truth is long term interest rates are going to continue to rise until we get some substantive bad economic news and we just don’t have any.

You look at the input of the numbers, first, estimates for third quarter GDP 4.9. That was not viewed as happy news by the Fed. Durable goods are up. A lot of airplane orders. There are no dramatic unemployment claims. Initial claims are still 200. Yields are up. Oil should be a lot more expensive than where it is. You’d think with the problems in the Middle East that oil would go through the roof. No. The sources of oil have diversified dramatically, and the United States is still the number one oil producer in the world which has an impact.

It’s been a year and a half now since the Federal Reserve started raising rates and we’ve gone basically from free money to five and a quarter. Okay, money markets are up. They’re in the fives. It’s been fundamentally good. You’d think that with changes like that we’d have a few major bankruptcies or a sharp drop in real estate prices or sharp drop in the stock market or other markets or some sort of significant slowdown with the consumer and we haven’t had any of that stuff.

The Federal Reserve has historically been looking for those things as sort of an indicator of what’s going on in the market and if their interest rates are having an impact on what’s going on. But no, retail sales in September and actually all of 23 have been excellent. They have recovered well. It’s not just yachts which are down. It’s not a lot of high ticket items, a lot of the demand for high ticket home improvements, that sort of stuff is kind of satiated right now. This is just basic consumer spending and it was very robust.

Some of that’s for Christmas, some of that is just spending because people are employed and they have money. And as you recall, the last time we looked at this, there were not a lot of outstanding balances on consumers’ credit cards. In fact, they’re down. The only issue that might be popped up right now is we have to go all the way to subprime borrowers and auto loans. Subprime meaning call our credit score below 650. News comes out oh, highest on record of bad loans 60 days or older in subprime lenders.

Well, what we’ve got is a tiny bit increase over what it was back in 90s, the car loan, subprime loan. Not dramatic and it’s certainly not warranted the headlines it got. The rest of the debt and the bankruptcies and the delinquencies and everything. As we’ve talked about before are at historic lows, no tension in the consumer, no collapse in real estate prices either we’ve finally gotten some movement in the growth of the medium price of residential homes, single family homes. They’ve stopped escalating so much and they’ve started to escalate less. Come down a little tiny bit. I wouldn’t call that a sharp drop in the price of houses. It’s more an adjustment to where we are and no impact on whether it’s affordable or not.

Fundamentally, for a basic guy, it’s really not affordable. But there’s not a lot of unemployment either. It’s just lack of inventory, CPI, PCE, all the various inflation gauges. Well, we had a tiny bit of monthly pop here for a little while but the PCE year over year is down to 3.7 on its way down here’s targeting 2% that’s a year away. That’s still on the path. Everybody the trend of this and the slope of this is pretty much in the can already inflation is under control and we are simply trying to time how it’s going to have an impact on what the Fed does when they lower rates.

The stock market it’s been unpleasant for a lot of people last month or so it’s been down, it’s tried to come back up, it’s been down. It’s certainly not a correction it’s more an adjustment for the little boom we had in June which had no rational justification people thinking that the Fed was going to lower rates right away maybe they overvalued the market. They did. They got ahead of earnings. We’re coming back down to where the earnings are. It is not bad news, it’s not horrible, it’s not gee, the market’s given up on everything. It’s simply back where it belongs.

Last week in the bond market was a very important event the ten year treasury, and we follow the ten year treasury you look at it today, it’s let’s call it 4.9, 4.8, whatever it is. Well, it was over five. The ten year treasury was over 5% last week and over 5% almost 3 hours and it was just being purchased as fast as they can. Anybody can get their hands on a ten year was buying it because if you’re an institution or insurance company or a large pension fund or something like that, it’s an opportunity for you to guarantee yourself a 5% return for ten years.

That’s not particularly attractive to a lot of individuals but for an institution or a bank or large sums of money it’s very attractive. A lot of money has left the stock market left the mortgage market, left all kinds of markets to go buy a ten year treasury at five that didn’t last. But it’s not going to come down. Meaning the prices of a tenure is not going to come up, brings the yield down.

Long term rates are going to continue to creep up. The 30 year, the ten year, even the five year, if you want to call that long term. They are going to creep up without any intervention from the Fed. We might get another quarter point out of the Fed sometime in the future. Today it’s a 50-50 chance that’ll happen because the work is already done. The market is adjusting and mortgages and so on and so forth are going to keep creeping up until something breaks. Consumer will break, price of houses, the stock market, something. That’s just what the rates are going to do.

And as bond yields go up, they become more attractive. Price is down, yield is up, they’re more attractive, and they’re simply going to be purchased by the billions. Question about banks and what sort of impact they had when the rates started going up. This is basically an interesting piece of information. Not that banks are really important, but they are indicative of how they’re affected by bonds. We’ve had free money for a decade. That’s over. When rates started to go up, the value of a lot of the assets that these banks, smaller banks owned, dropped.

Well, some of that’s arithmetic. But if your depositors come in and want their money and you have to sell your assets to give them your money, and the value of them is down, you simply have to sell more of those assets to give them their money. You know that kind of a loop. Well, that’s why we lost four banks. It didn’t dawn on them that rates were coming up and the value of their bond portfolio was going to go down. They didn’t change their duration. They didn’t do a lot of things.

So it was a great wake up call for the banking community and their assets. When three or four of them go under, which is what happened, all these unrealized losses are indicative of money isn’t free anymore. Money is now five and a quarter percent and it’s really not going to go down for the foreseeable future. So adjust to it. And if you’re a bank or an institution buying bonds now, it’s great because you’re buying them four and a half, 4.8, even 5% on long term bonds. It’s a good bond environment.

Finally, somebody asked me if we’re going to have another problem with the government shutting down in the middle of November, which we might. Has the market adapted to that? Has the market reacted to that? What’s the issue in the market? Well, this is sort of the answer. I don’t want to get in the technicalities of a credit default swap. Boy, there’s a mouthful. But this is a credit default swap market, how it was 2011, 2012. There were some issues about default, too much debt. But we just had a little spike in these swaps because we’re looking at the second government shutdown this year.

If there was an issue out there, not necessarily an economic issue, that might change the path of this economy, it’s pretty much in governance and politics. It’s not on the economic side. We’re still having the kids play out in the street with our money, and I don’t see that’s going to change. And it’s probably going to get worse in the next year until the presidential election next November.

Well, economically, we’re still doing fine. There’s no bad news, and I couldn’t predict where we might get it. It’s just rolling along. Have any questions, happy to deal with them. Send them along,

Thanks for joining me!

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