I thought it would be really hard to top Monday’s chaotic events in Parliament, but it looks like I was wrong. Today at 2 p.m., the U.S. Federal Reserve met, and boy oh boy, did things escalate quickly.
As part of the Fed meetings, the minutes are released along with the statement, and today’s minutes showed the Federal Reserve is likely going to reduce rates less than market expectations in 2025—a whole 50 bps less.
As I have often said, it matters not what the Fed, or the Bank of Canada, or a company reporting earnings, for that matter, say, but rather what the market expectation was. If the news is what was expected, the market shrugs. But when there’s a disconnect to the market, you get a powder keg explosion. Let’s jump right in.
When central banks speak, they parse their words very carefully—unlike a blogger you may know. They scrutinize every single word, they look at how it could be interpreted, they look at how it will be viewed. Today’s speech from Uncle Jay was a great example of what the industry generally calls ” Fed Speak.” When the minutes were released today, there were two massive items in the statement that caught the market’s attention:
- The Fed expects two quarter-point reductions in 2025, as opposed to the four it expected in September. Basically, there will be 50-bps of cuts next year instead of 100 bps of cut. Now markets have to re-price every financial instrument by 50 bps. Future earnings, forward cash flow projections, exchange rates, currencies, bond yields, you name it. And it all has to be re-priced to reflect the new rate expectation. Markets were way off.
- Let’s also remember that the Federal Reserve has a dual mandate of steady prices ( inflation) and employment. Since employment seems to be doing okay, the Fed doesn’t really need to pull any levers to get people to work. In fact, the U.S. unemployment rate is fairly decent, all things considered. The Fed statement indicated heightened concern about the return of inflation at this juncture and fears that dropping rates too fast could re-ignite inflation forces. Inflation around the world is starting to creep back, and the Fed alluded to it being more of a concern than it was before.
The Federal Reserve is in a great spot right now. They have the option to lower rates if need be, but are not really in a position where they must lower rates.
Now, contrast this to Uncle Tiff at the Bank of Canada who almost has his hand forced to lower rates at every meeting due to the declining economy and increasing unemployment levels. (Even though unemployment is not a BOC mandate, it goes hand in hand with the overall health of the economy).
Market reactions: CAD, equities, and bond yields
After the release of today’s statement, we saw a lot of things happen, and I am going to break them down for you and give you my two cents worth.
1. CAD got whacked, falling almost a full percent in the span of two hours. The CAD just dropped below 70 cents on Monday, and is now set to drop below 69 cents. This will widen the gap between the U.S. and Canadian overnight rates. I’m really at a loss for words to describe the complete gutting of the CAD in 2024. The currency market is telling you there is a lot of pain ahead. At some point, we will see a technical bounce, but that day ain’t today, and tomorrow doesn’t look good either.
2. Stocks took it on the chin, with the Dow Jones dropping over 1,100 points, and the S&P 500 plunging almost 3%. This makes sense as stocks now have to discount higher future interest rates. Stocks are a function of the future discounted earnings model, and the higher rates are expected to be, the lower stocks go to make up for that fact. Honestly, stock markets have been flying high this year, so this pullback doesn’t surprise. Stocks have been looking for a reason to pull back and reset, and today’s Fed announcement gave the market that perfect opportunity.
3. Interest rates. Holy smokes, how quickly things changed. After 2 p.m. the U.S. 10-year Treasury added 12 bps, now hovering at a critical resistance level of 4.50%, and the U.S. 2-year added 10 bps. A move through 4.50% takes the U.S. 10-year notes a lot higher, and Canadian 5-year bonds yields by default.
Canada 5’s were up a whisker over 9 bps to finish above the psychological 3.00% level, well about the 2.79% range we saw just a week ago. Look for lenders to be increasing fixed rates in the coming days, so get those pre-approvals in and send in any rate-drop requests tonight or tomorrow before rates climb. I have long been in the camp of rates higher (than most think) for longer (than most want). Today’s Fed meeting just showed that I am not alone in that thinking, and the bond market is now reacting to the pretty good potential of higher-than-anticipated rates.
The path ahead for bond yields and mortgage rates
If we see the U.S. 10 year yield clear the 4.50% range, then the next resistance level comes in nicely around 4.80%, a full 30 bps higher. If that were to happen, then Canada’s 5-year bond yield could easily add 20 to 25 bps to settle in the 3.25% to 3.30% range.
Rates moving and bouncing all around are probably my biggest concern as it makes borrowing harder, and economies are driven on borrowing money. Higher rates are also a headwind for mortgage brokers, housing, and homeowners.
With the 5 year hovering at 3.041% tonight, there is a real possibility that the Canada 5-year yield closes the year HIGHER than where it started. Imagine the wheels falling off the economy like they did, yet rates ending the year higher. Picture the BOC cutting overnight rates by 150 bps, only for the 5-year bond to remain elevated.
After the gong show that was Monday in Canada, we really needed things to calm down. We needed things to smooth out, volatility to go away, and to have a nice sail off into the year-end. Jay Powell decided he wanted to end the year with a bang, and a bang he did.
The original and unedited version of this article was originally posted for subscribers of MortgageRamblings.com. Those interested can subscribe by clicking here. Opinion pieces and the views expressed within are those of respective contributors and do not represent the views of the publisher and its affiliates.
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Last modified: December 18, 2024