By: Jeff Anderson, CFA
|Close||Weekly return||YTD return|
|Nasdaq Composite||13,351.1||-3.93%||– 14.66%|
|US Treasury 10 yr Yield||2.83 %||17.1%||131.6|
Source: Wall St. Journal
The major indices continued their slide in this shortened week as US Government bond yields continued to rise. In a recent CNBC interview, Federal Reserve Governor Christopher Waller said getting inflation under control will require raising interest rates at a faster pace than normal, even though the rate of price increases has probably peaked1. The probability that the Fed will raise rates by 0.5% vs the previously assumed increase of 0.25% has risen dramatically.
Fed Chairman Powell has history to guide him. Prior to Fed Chairman Paul Volcker getting aggressive with rate rises to bring down a multi-year battle with high inflation, his predecessor Arthur Burns was the opposite. Economic historians said Governor Burns “lacked the analytical framework to assess the interplay between the real economy and inflation, and how that relationship was connected to monetary policy.”2 By the time Volcker replaced Burns, inflation had become systemic. President Nixon had closed the gold window in 1971 (known as the Bretton Woods System) to address the country’s inflation problem and to discourage foreign governments from redeeming dollars for gold. His administration also enacted wage and price controls.3 It turned into economic mayhem. Powell is acutely aware of these risks. Better to be aggressive now than to let inflation boil over and create another lost decade.
Mortgage Rates Hit 5%:
We haven’t seen 5% rates since 2011. The monthly cost of buying a home has surged by more than a third over the past year, according to the Wall Street Journal. Yet, demand remains strong (for now). In areas like Southern California, a strong labor market coupled with extremely low supply could offset this. The cost of building materials has risen dramatically, and homebuilders are forced to charge more to maintain profit margins. It will be interesting to see what the total demand for mortgages is for 2022. In 2021, nearly two thirds of originations came from refinancing. Economists had projected, a few weeks back, that this number would be closer to 30%. As prices continue to rise, so are rents. This upward pressure on rents may push reluctant buyers into the market as the cost of renting may no longer make sense.
China is Back to Covid-19 Lockdowns:
Just when we thought covid-19 and all its variants were in the rearview mirror, China is back to mass lockdowns. Forty-five cities that make up nearly 40% of China’s economic output are in some form of lockdown. This equates to roughly 370 million affected Chinese residents. There is already significant disruption to the Chinese economy, and it won’t help the global economy fight its way out of its supply-chain issues. Let’s hope this is the last set of measures necessary to put an end to this pandemic.