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The Fed will still raise rates in March
When it comes to interest rates news, there is definitely a chicken/egg problem. Are rates being moved by the Fed's decisions? Or are rates affected by market forces, which force the Fed to react?
The answer lies somewhere in the middle. The answer is somewhere in between.
The Fed has been quite active since March 2020. After a period of rate-friendly policies, they became very unfriendly in 2022."Unfriendly" in this instance refers to raising the Fed Funds rate and buying fewer bonds on the open market. The combined result was one of the most dramatic rate spikes in history.
After more than a year in which the Fed was unfriendly, they are now considering leveling off and observing how things go without any further rate increases. They have already reduced the pace from 0.75% per meeting to 0.25%.
The latest sign is the banking drama, which has been in the news this week. It started with Silicon Valley Bank last Wednesday, but it spiraled into a larger problem with Signature Bank's closure over the weekend. These institutions are the 2nd and 3rd largest bank collapses in US history.
Credit Suisse is a name that many people have heard of. Markets reacted to the news that the European institution could be swept up in the recent drama, despite the fact that it has been on the unstable ground for months. The stock price plummeted nearly all week, and other European banks moved lower in sympathies.
All of these factors contributed to another week of market volatility. This involves selling more risky assets such as stocks and buying bonds. If traders buy bonds, it pushes down interest rates (represented by the US 10yr Treasury yields shown in the chart below). All other things being equal
Despite panic in the financial markets, the Fed will almost certainly continue raising rates next week, despite the apparent panic. It will almost certainly signal that additional rate increases are possible, or probable and that they depend more on the path to inflation than on a few mismanaged banks having trouble coping in a difficult rate environment.
Keep in mind that markets are less interested in the Fed changing rates at the current meeting than they are in the future rate outlook. This outlook is driven by two things: The Fed's stance on economic issues and the economy itself.
The Fed's rigid stance on rates makes it difficult for the economy to experience high growth. This will also mean that inflation will be less likely to resurgence. This will result in downward pressure on rates over the long term.
The current week's rate drop was not due to a flight to safety but also because of the expectation that the Fed would be able to begin cutting rates by the end of the year. The following chart shows September's Fed Funds Rate Expectations falling below March.
The mortgage market is not so fortunate. A classic flight to safety tends first to benefit Treasuries, even though the 10-year Treasury is often used to benchmark mortgage rate movements. The mortgage market has improved, but not as much as Treasuries.
It's okay. Slowly improving mortgage rates is the best way to make a sustainable improvement. The chart above shows that the housing market already recognizes the ceiling in rates. Housing metrics have been slowly falling since their highs in 2022. This is evident in the latest builder and construction confidence data released this week.
Next week, existing and new home sales will be released. However, when it comes to market movements and the impact rates have on them, all eyes will be on Wednesday's Fed events.
Why are these events important? It's not only Wednesday's Fed rate hike. They will also receive a number of updates to the policy announcement's verbiage. These words will help to frame the policy path moving forward. The updated forecasts for future rate increases (or reductions) will provide market participants with more clarity and insight. Each Fed member submitted updated forecasts for future rate hikes (or cuts)These forecasts will likely not match market expectations. It will be interesting to observe how the market reacts to this reality.
Last but not the least, every Fed Day ends with a press conference by the Fed Chair. This conference will be one of most informative and important in recent memory. Powell will have to choose between calming panicked markets and setting policy goals.
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