As anticipated in Friday’s update, mortgage bonds came within a whisker of their 200 Day Moving Average and were forced sharply lower. With the Fed announcement behind us and without a rate increase, mortgage bonds will likely be subject to sharp downward movements if strong economic reports and higher inflation numbers continue. With the Fed too timid to push short term interest rates higher, the market will likely do the Fed’s job for them by pushing yields on longer term maturity bonds higher to compensate for the increased cost of higher inflation. A rate hike would have calmed the markets fear of continued inflation and certainly is justified given current economic conditions. Our economy is much stronger than it was when near 0% interest rates were needed to help stimulate growth. At this stage in our economic recovery, the market can easily absorb higher yields as long as upward adjustments are incremental and at a reasonable slow pace.
The Federal Reserve released their Dot Chart, showing when the Fed members believe rates will be pushed higher and where they think the Fed Funds Rate will be over the next several years. Of the 17 members, there are 13 who believe the hike will happen before the end of the year, while three think the first hike will be in 2016 and one sees the initial hike delayed until 2017. This adds to the high probability that we will see a rate hike in December, if not sooner. The chart shows that most see the rate hikes in over the next few years coming in small increments. However, future predictions have not been their strong point the past few years. We will have to see how the economy performs to determine how accurate their projections are.
Given the Fed’s lack of courage to raise rates, we see a higher probability of mortgage rates rising in the near future. Unless there are significant downgrades to the US Economy over the next few days, bonds will likely move toward the bottom of their trading channel. Therefore, we will maintain our locking bias.