With inflation retreating, focus now on bond yields given impact on mortgage rates
What with its seven interest rate hikes in quick succession to curb inflation, last year was all about the Fed. The year 2023 will spur a pivot in focus, however, as it’s poised to be all about bonds.
So says Melissa Cohn (pictured), regional vice president of William Raveis Mortgage, whose 40 years’ worth of experience informs her economic insight. She spoke to Mortgage Professional America to explain how 2023 will be the year to keep a more focused look at bonds rather than rates.
A wild ride for the real estate markets
To be sure, 2022 represented a dizzying ride for the mortgage and real estate markets, with the Fed having to step in with aggressive interest rate hikes to tamper inflation. The good news, according to Cohn: The plan appears to be working, and it hasn’t flattened the economy, as many feared — at least not yet.
Rather than focus on rates, she’s trained her sights on the bond market as a forward-looking indicator that serves as a barometer of overall economic health. “Bad news for the economy and bad news for employment is good news for bond yields,” she explained. “Currently, bond yields are trading at 3.44% — that’s almost a full percentage point lower than where they peaked in November at 4.3%.”
That’s a good sign for the economy and, by extension, the real estate market, Cohn noted. To her, those signs suggest “we’re starting off the year on the right foot,” she said.
CPI report bodes well for the future
Another favorable sign emerged last week in the form of the Consumer Price Index (CPI) released by the US Bureau of Labor Statistics. The report showed US consumer prices fell for the first time in two and a half years in December, suggesting inflation is on a downward trend.
The latest inflation report showed a continued cooling down in year-over-year prices, at 6.5% from 7.1% in November. The snapshot excludes food and gas prices that tend to be more volatile.
“With that good CPI number, the driver in mortgages – and therefore in many ways the driver in the real estate markets – is going to be the economy,” Cohn said. “It’s going to be the beyond market.”
Fed’s actions are meant to tame inflation
While noting the Fed’s actions appear to be yielding results in curbing inflation, she was taken aback the central bank didn’t allow for the traditional six-month period between rate hikes to test its impact on the market as it historically has done.
Instead: “The Fed raised rates seven times last year in an effort to squash inflation, but never waited for that timeframe to happen,” she said. “It just kept raising rates at each meeting. As a result, we are now watching an economy that’s grappling in a much higher rate environment. We are seeing that inflation is moderating and we also see signs of weakening in the economy.”
But she reverts to her “bad news for the economy is good news for bond yields” mantra to explain the positive impact on mortgage rates. “The mortgage rates are not tied to the bond market,” she reiterated. “And the bond market is basically reacting to economic data to project where they think the markets are going. Bond yields since November have dropped by almost a full percentage point, and mortgage rates have dropped along with that.”
The knee bone is connected to the thigh bone…
Think of it like bone linkages: “The connection is sort of like the knee bone is connected to the thigh bone kind of thing, where the inflation rate is attached to the bond yields which are attached to mortgage rates,” she said. “So as inflation comes down, bond yields come down and mortgage rates come down.”
That sets the stage for a new narrative – a time to bring out the figurative popcorn to watch how it all might unfold: “This year, we will see the direction of rates based on where the bond market goes,” Cohn said. “If we continue to get weaker economic data, if we continue to see the rate of inflation is being reduced on a monthly basis, mortgage rates will continue to come down.”
Like a movie trailer catchphrase, Cohn summarizes the new plot line for added effect: “2022 was the year we followed the Fed. 2023 is going to be all about the bond market.”