Market Update: July 16, 2023
Nominal Rates & the Fed
Positive inflation numbers released last week, signaling to the Fed that our economy is still strong. But those bullish investors were probably happy, likely thinking these numbers will slow the Fed down or encourage them to take another pause in their rate hike campaign. Several banks reported earnings at the end of last week, and there was no shortage of good news there.
Money market rates are opening a spot for another rate hike: the rates on one-month through the six-month are breaching close to or above 5.5%, potentially signaling another rate hike soon. And the market is already making interest rate cuts on the longer duration capital market rates. If capital market is pricing in rate cuts and the money market is pricing in a rate hike, our inverted yield curve deepens. A yield curve measures the value of short-term bonds vs. long-term bonds. A normal yield curve shows bonds with longer duration earning higher yields than bonds with shorter duration; this is considered normal because creditors earn more by lending out their money for longer periods. But in times like these, when interest rates rise quickly, we experience an inverted yield curve that shows short-term bonds earning more than long-term bonds. And when we look at earnings from the banks, loan volume is up, meaning these higher rates haven’t deterred individuals and companies from borrowing.
The bank of Canada raised their interest rates again, leading to further deepening of the yield curve. This was unexpected given the sensitivity that Canadian households have to interest rate volatility. In the Canadian mortgage market, you can get a 25-year mortgage that’s broken up into five separate 5-year loans; this requires Canadians to renew their loans every 5 years. For those homeowners who are headed towards renewal, they’re looking at substantially higher mortgage payments for the next 5 years. Could you imagine if the US modeled its mortgages in a similar way? If we did, the Fed would be getting even more push back every time they raised rates.
And after last week’s influx of funds, total money market funds are down by $20.37 billion: retail increased by $5.23 billion, but institutional fell by $25.6 billion to eclipse retail funds.
Real Rates, Federal Funds Rate, and TLT
Real rates all retreated last week, after hitting recent new highs.
Federal fund futures (FFF) again seem to bottom out in November and December. This tells us the market has priced in one rate hike and no rate cuts.
TLT, the major long-term bond ETF index, is up 2.23%.
Housing & OAS
The Primary Mortgage Market Survey shows 30-yr. Fixed Rate Mortgages (FRM) are at 6.96% (up 15 bps from last week) and 15-yr. FRM are at 6.30% (up 6 bps from last week).
Home developers are back to reporting significant gains, this time achieving some all-time highs; this means they’re higher than they were in the housing boom leading up to the sub-prime mortgage meltdown, otherwise known as The Great Recession. On average, developers are reporting gains of 11% and beyond.
CPI & PPI
CPI measures the Consumer Price Index, which tracks the total value of goods/services bought over a specified period; in other words, its focus is on consumers. PPI measures the Producer Price Index, which tracks the change in selling prices received by domestic vendors; its focus is on producers. Another way to think of it is this… Consider a standard hospital visit: if the patient (a consumer) pays for it, it’s captured in CPI; but if the insurance company pays for the visit, it does NOT get captured in CPI. On the PPI side, it gets tracked no matter who pays for it, because it represents the money the producer receives for the hospital visit.
CPI reports last week showing an overall increase from last month of 0.2% for all items. In the eyes of the Fed, that’s great news. It indicates that inflation is mostly under control and the economy is handling it. It may not be positive enough to warrant another pause in rate hikes, but it indicates things are moving in the right direction. Some of the most notable CPI changes came from:
- Fruits and vegetables (+0.8%)
- Energy (+0.6%)
- Electricity (+0.9%)
- Motor fuel (+0.9%)
- Utility (piped) gas service (-1.7%)
- Motor vehicle maintenance and repairs (+1.3%)
- Motor vehicle insurance (+1.7%)
- Airline fares (-8.1%)
Controversies around corn and wheat caused price drops last week for both commodities. But going into last Friday, they experienced a rally. Both corn and wheat supplies face harsh summer heat throughout the Northern hemisphere.
The highlight is the Black Sea Grain Initiative, an agreement that allows Ukraine to export its grain by sea despite a wartime blockade, which many see as essential to maintaining global food prices. Russia has pulled out of the Initiative, which threatens the global transport of grain and will surely have an adverse effect on price.
Copper and aluminum are going to be hot commodities as e-vehicles continue to gain traction. Copper had a great week, experiencing a significant jump. Despite low year-to-date gains, copper miners reported gains last week averaging 6.26%. Aluminum isn’t doing so hot. One aluminum producer has reported year-to-date losses of 22% but seeing a small bounce back in the last week or so.
This newsletter is a synopsis of a continual series of updates by a market analyst Mark Meldrum. Mark Meldrum is a CFA that provides weekly updates on the market, but they tend to be an hour long. Here is a synopsis of his video found here.
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