Sifting Through Ashes For Seeds Of Hope

There’s no way to sugarcoat the situation in the bond market and, by extension, the mortgage and housing markets. Rates have risen at a nearly unprecedented pace, ushering in one of the quickest cooldowns on record. One of the only ways to find hope in this environment is to imagine that bad news is finite. To be clear, “bad news” is relative, because it has been the resilience of the domestic economy that has allowed rates to rise as aggressively as they have so far.  This isn’t necessarily a direct relationship, but the Fed is looking for a few pieces of evidence that its unfriendly policies are having the desired effect, and one of those pieces would be rising unemployment.   So far, unemployment has remained low, inflation has remained high, and the Fed has remained very unfriendly toward rates.  They’ve been so unfriendly that market participants have increasingly wondered how much they can get away with before signs of uncommon stress show up in rate markets and elsewhere. We may have witnessed some of that stress this week–especially in the second half which saw longer-term rates surge higher without any obvious provocation.  At this point, we should distinguish between longer term rates (like 10yr Treasury yields or mortgages) and shorter term rates (like a 2yr Treasury or the Fed Funds Rate).  Differences in the behavior between long and short term rates can offer clues about market psychology. In the 2nd half of the week short term yields moved higher, faster at first.  When shorter-term yields are rising faster in 2022, it often goes hand in hand with the perception that the Fed will be hiking its Fed Funds Rate faster.  To illustrate this point, here’s a quick look at the relative movement in 2yr Treasury yields and Fed Funds Rate predictions for September 2023.
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