Safe Play will be to Lock

Mortgage bonds suffered significant losses yesterday, as bond investors sold in advance of this morning’s reading on CPI and tomorrow’s highly anticipated rate announcement from the Federal Reserve. The selling pressure was so strong that bonds broke through multiple layers of support and are now sitting beneath all their moving averages. In the meantime, the US stock market has powered higher ahead of the Fed announcement. Many stock investors are betting that the Fed will decide to hold rates steady for now. A hike in the Fed Funds rate would generally be negative for the stock market, as higher borrowing costs combined with a stronger US dollar would add headwind to international businesses based in the US.

The Consumer Price Index (CPI) for the month of August was reported to be -0.1%. This was lower than the 0.0% anticipated and shows that inflation on the consumer side is still not an issue. This low reading adds further confusion to the Fed in making their decision as to whether or not to raise interest rates. A rate hike in an economic environment that has stagnant inflation could lead to further deflation. The Fed has decided that the healthy balance is to have inflation growing at 2% or so per year. Anything much greater than that could create an economy where price growth greatly exceeds income growth. While levels below that create stagnant growth where consumers are delaying purchases in hopes of lower prices in the future. Both of which are destructive to the economy.

Tomorrow is one of the most significant days in the market that we have seen in a long time. If the Fed chooses to raise rates, it would be the first time in more than nine years that we have had to deal with higher short term interest rates. If the Fed chooses to hold, the market could decide to do the work of the Fed organically by raising rates on loans that aren’t driven by the Fed (such as mortgage interest rates). The chances of a rate hike remain near 50/50. Therefore, deciding whether to lock a rate is a difficult decision. The safe play will be to lock in to avoid the potential impact of rates jolting higher.