The Market Today

Even the Doves Anticipate Rapid Return to Neutral

by Craig Dismuke, Dudley Carter

VINING SPARKS ECONOMIC OUTLOOK WEBINAR: We will host our 2Q Economic Outlook Webinar on Thursday, April 7 (click here to register).  We will walk through the current inflation environment, highlighting the uncertainty that lies ahead.  We will also look at the historic pivot for monetary policy during 1Q and the implications of the inverted yield curve that has resulted.



Mortgage Rates Continues to Rise: Mortgage applications fell another 6.3% for the week ending April 1 as mortgage rates continue to shoot higher rapidly.  The average 30-year mortgage rate, according to the MBA report, rose another 10 bps to 4.90%, its highest level since 2018.  Other mortgage rate reports show rates at their highest level since 2013.  With the average homeowner mortgage rate down to 3.37%, according to data aggregated by the Federal Reserve, the current level for rates is clearly a headwind for activity.  For the reference week, purchase apps fell 3.4% and refi apps fell another 9.9%.

Fed Communications: Philadelphia Fed Bank President Harker (non-voter) is scheduled to speak at 8:30 a.m. CT. Richmond Bank President Barkin (non-voter) is scheduled for 9:00 a.m.  Perhaps most important given Governor Brainard’s comments on the pace of balance sheet run-off yesterday, the FOMC Meeting Minutes from the March 16 meeting will be released at 1:00 p.m.  The outlook for rate hikes has already been ratcheted higher since the meeting but any discussion on the pace of run-off could create some volatility for an already-skittish market.


ISM Services Index Recovers on Broadly Better Details: The ISM’s survey of businesses across the U.S. services sector came up short of expectations in March, although the mathematical disappointment was mostly the result of fewer logistical delays. The headline index recovered from 56.5 to 58.3, breaking a string of three monthly declines that had pushed the index down to its weakest level since February 2021. There was broad improvement across most of the key details, including a 2.8-point drop in the supplier deliveries index, a real-world positive that shaved 0.7 points off the headline PMI. The employment index recovered 5.5 points to 54.0 after contracting for the first time since June 2021 and new orders recovered 4.0 points to 60.1. The business activity index was largely unchanged near its weakest reading since the initial months of the pandemic early in 2020. Although neither impacted the calculation of the headline PMI, new export orders accounted for the largest monthly gain with an 8-point bounce while inventory sentiment sank 15.1 points back to the low end of the pandemic range, indicating businesses believe current inventory levels are too low. Notably, the prices paid index inched higher, nearly matching its all-time high level from December.

Bond Yields Broke Higher after Hawkish Brainard Speech: Fed Governor Brainard moved markets Tuesday with a speech supporting those that believe the Fed is tracking to tighten policy rapidly this year to control inflation, despite growing concerns about the ripple effects tighter conditions will have on an economy already dealing with numerous uncertainties. Brainard said, “the full extent of additional tightening over time [will depend] on how the outlook for inflation and employment evolves,” also noting that, “at every meeting, we will have the opportunity to calibrate the appropriate pace of firming through the policy rate.” However, the markets dismissed her pledge to be data dependent and paid more attention to her comments describing her current expectations. “It is of paramount importance to get inflation down,” Brainard said, and therefore the Fed “will continue tightening monetary policy methodically through a series of interest rate increases and by starting to reduce the balance sheet at a rapid pace as soon as our May meeting. Given that the recovery has been considerably stronger and faster than in the previous cycle, I expect the balance sheet to shrink considerably more rapidly than in the previous recovery, with significantly larger caps and a much shorter period to phase in the maximum caps compared with 2017–19.” Summing up her broader policy paradigm, Brainard said, “I expect the combined effect of rate increases and balance sheet reduction to bring the stance of policy to a more neutral position later this year.” Though less covered in news reports, comments from Fed Presidents George and Daly echoed Brainard’s hawkish tone.


Curve Slope Turns Positive and Yields Hit New Cycle-Highs after Hawkish Brainard Comments: There has been much debate in recent months as to whether the Fed running off securities it added to its balance sheet during the pandemic would put upward pressure on longer yields and help steepen the curve. Investors got a glimpse of one of the possible scenarios on Tuesday. Stealing some of the thunder from today’s Fed Minutes, Fed Governor Brainard said that the Fed will begin to rapidly shrink its balance sheet as soon as the May meeting and continue “methodically” tightening to return the Fed’s overall policy stance to a near-neutral setting by year’s end (more above). The Treasury curve steepened sharply higher on her remarks and equities slid. The S&P 500 ended down 1.3% and near session lows. Monday’s biggest winners were Tuesday’s biggest losers as investors dumped tech for the relative safety in utilities and real estate, two sectors that typically are negatively correlated with moves in interest rates. Both, however, rose together on Tuesday. Excluding March 2020’s volatility and the day after the 2016 Presidential Election, the 10-year yield’s 15.2-bp surge was biggest single-day gain since July 2013 and its close at 2.55% marked a new high since April 2019. The 2-year yield rose 9.2 bps to 2.51%, its highest close since March 2019, leaving the spread between the two yields in positive territory for the first time since Wednesday. The 5-year yield jumped 14.5 bps to 2.70%, its highest close since December 2018. Fed funds futures closed pricing in roughly 2.20% of additional tightening this year, implying more than an 80% chance of a 50-bp hike in May and at least some possibility of a 50-bp move at each meeting for the remainder of the year except December.

Treasury yields continued to climb Wednesday in global trading, pushing the yield curve to new cycle highs and placing additional pressure on equity valuations. Weaker equity pricing was seen across both Asia and S&P 500 futures were down 1.0% at 7 a.m. CT. The tech sector continued to bear the worst of the rout, leading losses in foreign indices and knocking another 1.6% off the Nasdaq. Chinese stocks were little changed in their return from a holiday despite another economic report showing the damaging combined effects of the country’s zero-COVID-19 policy and the new wave of the virus across the country. A private PMI survey of services sector activity in China plunged more than expected from 50.2 to 42.0 in March, its sharpest contraction since February 2020. While Fed officials have acknowledged that the situation in China and Ukraine do pose some risk to growth, they have placed greater emphasis on the upside risks both situations create for inflation that is already unacceptably high. Spurred along by the latest hawkish Fed commentary (more above), the 10-year Treasury yield led a rise in longer global yields, adding 7.5 bps to 2.62%, its highest level since March 2019. The 2-year yield was 2.1 bps higher at 2.54%, its highest level since March 2019. The 5-year Treasury rose 5.3 bps to 2.75%, a new high since December 2018. Interest rates may see additional volatility today around the release of the Fed’s Minutes, which investors expect could lay out in detail the Fed’s plans for normalizing its balance sheet, including how quickly the securities portfolio will be allowed to roll off.

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