Fra Moody’s
Fed’s Pause May Refresh a Tiring Economic Recovery
As high ranking Federal Reserve officials reiterated many times earlier, monetary policy is not on a preset course. As outlooks for consumer price inflation, business activity and systemic liquidity change, so will monetary policy. Both January 30 release of the FOMC’s policy statement and Jerome Powell’s ensuing press conference assured markets that any normalization of Fed policy will not be indifferent to downwardly revised economic outlooks, industrial commodity price deflation, and volatile financial markets.
As inferred from the CME Group’s FedWatch Tool, the probability assigned to a fed funds midpoint that exceeds its current 2.375% at any point in 2019 has practically vanished. The implied probabilities of a Fed rate hike recently were 1.3% for the FOMC’s June 19 meeting, 1.2% for the September 18 meeting, and 1.0% for December 11’s meeting. In fact, fed funds futures recently implicitly assigned a much greater 20% probability to the likelihood of a Fed rate cut at the December 11 meeting.
However, these implied probabilities can change radically depending on business conditions, inflation expectations, and the outlook for systemic liquidity. Right now, financial markets anticipate a satisfactory pace for business activity. Once markets sense an acceleration of expenditures, both Treasury bond yields and the implied probability of a Fe d rate hike will
rise.
Extended Upturn by Base Metals Prices Might End Slide by Treasury Yields. The recent rise by business-cycle-sensitive industrial metals prices hints of a firmer tone to global industrial activity, albeit from subdued pace. Though Moody’s industrial metals price index for January 30 was down by 14.2% from its year-earlier-reading, it was up by 6.2% since the end of 2018.
The record suggests if the industrial metals price index extends its latest climb, the 10-year Treasury yield’s slide will come to an end. Nevertheless, according to month-long averages since the end of 1983, the 10-year Treasury yield fell year-over-year for 41, or 84%, of the 49 months showing a yearly decline between 10% and 15% by the base metals price index. The eight deviations from this trend occurred in January 2019, November 2018, February 2014, July-August 1996, and July-September 1984.
However, January 2019’s divergence from trend may not persist. Current indications are that February 2019’s month-long average for the 10-year Treasury yield will be less than its 2.86% average of February 2018.
Mortgage Applications Hint of Livelier Home Sales and Stable Interest Rates. In addition to industrial metals prices, interest-sensitive spending will offer insight regarding the likely irection of benchmark interest rates. November 2018’s sales of new homes well exceeded what were very modest expectations and surged higher by 16.9% monthly to a seasonally adjusted and annualized pace of 657,000 units.
November’s pace was the liveliest month for new home sales since the 672,000
annualized units of March 2018. Nevertheless, despite November’s strong showing by new homes sold, the sum of the new and existing home sales for the three-months-ended November 2018 contracted by 9.7% annualized from the contiguous three-months-ended August 2018 and dipped by 5.5% year over year.
Fourth-quarter 2018’s average for the National Association of Realtors’ index of pending sales of existing homes fell by 7.4% year over year before seasonal adjustment and contracted at an annualized rate of 15.2% from 2018’s third quarter after seasonal adjustment. Fourth-quarter 2018’s seasonally-adjusted average for the index of pending home sales appears to be the lowest of any calendar quarter since 2014’s second quarter, or when home sales were beginning to recover from a brief slump triggered by the
short-lived jump in Treasury bond yields stemming from the taper tantrum.
The FHLMC’s benchmark 30-year mortgage yield averaged 4.78% in 2018’s final quarter, which was greater than both the 4.57% of 2018’s third quarter and the 3.92% of 2017’s final quarter. However, the 30-year mortgage yield’s latest decline to the 4.46% month-long average of January may help form a bottom for home sales.
January’s 12.8% jump from December 2018 by the Mortgage Bankers Association’s index of mortgage applications for the purchase of a home brightens housing’s prospects. Nevertheless, as far as predicting existing home sales two to three months hence, pending home sales’ 0.89 correlation with future existing home sales is stronger than the 0.74 correlation of homebuyer mortgage applications.
Still, January’s outsized 12.8% monthly increase by homebuyer mortgage applications may prove telling. For those six months since December 2011 that showed a greater than 6% month-to-month increase by homebuyer mortgage applications, the accompanying index of pending home sales grew by 1.1% monthly, on average, while the average pace for existing home sales two to three months hence rose by 1.2%, on average.
Higher Systemic Leverage Lowers the Upside for Benchmark Interest Rates. The world’s lower-than-anticipated benchmark interest rates of 2019-to-date brings attention to the heightened sensitivity of more highly leveraged economies to interest rate swings. As business activity becomes more dependent on debt to support asset values and fund spending, interest rate fluctuations will exert a greater influence than otherwise over expenditures, financial markets and commodity prices. All else the same, at higher ratios of nonfinancial-sector debt to GDP, a percentage point increase in interest rates may trigger a deeper percentage decline in earnings-sensitive security prices, commodity prices and expenditures.
If the U.S. and world economies recently had difficulty shouldering a 3.00% to 3.25% 10-year U.S. Treasury yield, imagine what might happen if the world’s benchmark bond yield
approached 4%.
