MBS prices are about 25 basis points better than yesterday morning based upon, a good PCE inflation report this morning showing Core PCE prices only increased by 0.1% in August, and the personal spending report that showed consumer spending increased by 0.2% in August, below the 0.3% market prediction and the 0.5% increase in July.

These two reports showed a gently slowing economy, which decreases the market’s’ worries about a hard landing recession. This view was further supported by the University of Michigan Consumer Sentiment Survey which came out today at 70.1, which was above the market’s prediction of 69.3 and above last month’s 69.0. This was the highest level in the last five months and a survey showing increased consumer confidence often leads to stable or increased consumer spending in future months.

If the inflation numbers continue to come out low each month, this will allow the Fed to increase the pace of the Fed Funds rate cuts. After today’s reports, the Fed Funds market is predicting a 52% chance of a 50 basis point rate cut in November. This was a 50% probability earlier this week. The yield on the 10-year Treasury is presently 3.752% which is on the lower endo of its trading range this week. The weekly high was 3.815% and the low was 3.726%. Tensions in the Middle East continue to create volatility in the 10-year Treasury bond yield as it is considered the safest, and mostly widely owned bond in the world, so demand for this bond increases during times of world crisis.

The Fed’s Strategy.  One of the Fed’s top objectives is to smooth out the normal market boom and bust cycles in the U.S. economy. The Fed raises and lowers the Fed Funds rate to act as a brake and gas pedal for the economy. If the economy grows too fast, this will almost always end up in a sharper future recession. The Fed’s ideal scenario is to have many years of a moderately growing economy, which helps the eventual recession be shorter and shallower.

If the Fed thinks the economy is growing too fast, they will raise the Fed Funds rate (apply the brake pedal) to help slow the rate of growth. If they think the economy is growing too slowly, or is in a recession and is actually contracting, then the Fed will cut rates (apply the gas pedal) to try to put more cash into the hands of consumers and business to stimulate the economy.

Whenever an economy slows down, or begins to contract in a recession, the unemployment rate goes up. A high rate of layoffs and of unemployment creates emotional and financial pain to people and to our economy. The Fed is very focused to try to achieve short and shallow recessions to minimize the impact to human beings but still achieve the important benefits of a recession which corrects the prices of assets, goods, and services in our economy. 

The Fed’s Rate Cut Timing.  As the Fed cuts rates, this puts more cash into the hands of businesses and consumers, which helps create new jobs and reduces the rate of unemployment. If too much cash is injected into the economy, this could increase inflation. The Fed is trying to choose the magic amount, and timing of rate cuts, to prevent a large spike in unemployment without rekindling inflation rates.

When the Fed cut rates 50 basis points earlier this month, this created worries in the markets the Fed may be cutting too aggressively to try and head off a hard landing scenario, which would likely result in a large spike in unemployment. The markets were worried that the Fed would be pushing inflation higher at the same time. As much as any Fed rate cuts are generally good for bond prices and mortgage interest rates, anything that drives up inflation is clearly very bad for interest rates, particularly for long term fixed rates, such as mortgage rates. The markets were worried that if the Fed was cutting too much, too quickly, i.e. doing 50 basis point rate cuts at each meeting, then this could spike inflation rates, and this would then push up long term interest rates. This is exactly why we saw MBS prices worsen on many days after the Fed’s 50 basis point rate cut.

The future direction of inflation will determine the future level of mortgage rates.  Today’s reports show that inflation as of August was continuing to subside. The markets will be keenly focused on the September and October inflation reports to see if any increase in inflation begins to occur post official Fed rate cuts. 

As a reminder, spending by consumers and businesses can drive inflation pressures, but they are not the only sources of inflation in our economy.  Government spending also drives up inflation rates, since the government is also hiring people, buying goods, and contracting for services, which bids up the prices for all of these items, and leads to inflation. Also, government policies can impact the price of goods and services, such as oil, agricultural and construction.

This Market Update and similar such communications are for informational purposes only and are based on publicly available information. These materials are general communications, which are not impartial, and are provided solely for discussion purposes, and not in connection with any product or service offering. The opinions and views expressed in this Market Update are as of the date of this communication and are subject to change. Any forward-looking views and statements contained in this Market Update are based on current estimates or expectations of future events or results. Actual results may differ materially from those described in this Market Update. The views expressed in this communication should not be attributed to Guild Mortgage Company as a whole and may not be reflected in the strategies and products offered by Guild Mortgage Company.