As expected, The Federal Reserve raised their target rate by 50 basis points to 4.50%, the highest Fed target rate since November 2007.
The only thing interesting that happened was Powell’s hawkish statements about The Fed wanting to keep tightening to fight inflation caused under “Inflation Joe” Biden.
But the NEW Fed Dots plot looks like an Olympic Ski jump with expectations of DECLINING Fed target rates.
My take on the steeply downward sloping Dot Plot is a tacit acknowledgement that a recession is headed our way in 2023.
Here is the Lillehammer Olympic ski jump that resembles today’s Fed Dots Plot.
Apparently, despite the denials from the Biden Administration, someone at Bureau of Labor Statistics or someone in Congress or the Federal Reserve or the Biden Admininstration itself likely tipped the wink on the soft CPI report on Tuesday.
Treasuries were well on the front-foot in the lead up to the below-estimate November CPO print, as a surge of buying took place seconds before the official 8:30 am New York release time. Over a 60 second period before the data, 13,518 March 10-year futures traded as the contract moved from 114-04+ up to 114-22. Gains were then extended up to 115-11 session highs once the data was released.
On the equity side, stock futures suddenly spiked more than 1%. Trading in Treasury futures surged, pushing benchmark yields lower by about 4 basis points. Those are major moves in such a short period of time — bigger than full-session swings on some days. And they should get scrutinized by regulators, long-time market observers say, even if a leak is only one of several possible explanations for why traders suddenly started buying right before the report was published.
Remember that current Treasury Secretary Janet Yellen was accused of leaking information to a NY hedge fund ahead of the Fed Open Market Committee meeting? And then we have the Wolf of Wall Street.
I wonder if the REAL Wolf of Wall Street did this?
Mortgage applications increased 3.2 percent from one week earlier, according to data from the Mortgage Bankers Association’s (MBA) Weekly Mortgage Applications Survey for the week ending December 9, 2022.
The Refinance Index increased 3 percent from the previous week and was 85 percent lower than the same week one year ago. The unadjusted Purchase Index decreased 1 percent compared with the previous week and was 38 percent lower than the same week one year ago.
You can see the impact of seasonalilty on mortgage purchase applications (white line). They peaked in the week of May 6, 2022 and have been generally declining since. While refi applications (orange line) increased over the past week, they have been pummelled by The Fed tightening.
It is quiet today as investors wait for The Fed to announce a 50 basis point rate increase. Fed Funds Futures point to almost another 100 basis point hike by May 5, 2023, then a slow decline in The Fed Funds target rate (upper bound).
And here is Sam Bankman-Fried and his high-powered legal defense.
Fun week ahead. US inflation numbers are out on Tuesday (forecast? CPI YoY = 7.3%, Core CPI YoY = 6.1%) and The Federal Reserve’s Open Market Committee (FOMC) rate decision is on Wendesday.
So, where are we sitting on Monday?
First, the US Treasury 10Y-2Y yield curve has been inverted (a precursor to recession) for 116 straight days). Second, the likelihood of recession in 2023 is 100%. Third, with the forecast of core inflation at a still numbing 6.1%, The Fed seems dead set on raising their target rate by 50 basis points to 4.50% on Wednesday.
dddd
So, as The Fed debates recession versus fighting inflation (partly caused by The Fed), we have Kevin Malone from The Office debating Angela versus double-fudge brownies:
Central bankers won’t ride to the rescue when growth slows in this new regime, contrary to what investors have come to expect. They are deliberately causing recessions by overtightening policy to try to rein in inflation. That makes recession foretold. We see central banks eventually backing off from rate hikes as the economic damage becomes reality. We expect inflation to cool but stay persistently higher than central bank targets of 2%.
For some investors, this year’s rout in high-flying technology stocks is more than a bear market: It’s the end of an era for a handful of giant companies such as Facebook parent Meta Platforms Inc. and Amazon.com Inc.
Those companies — known along with Apple Inc., Netflix Inc. and Google parent Alphabet Inc. as the FAANGs — led the move to a digital world and helped power a 13-year bull run. And FAANG drawdown have reached over $3 trillion.
FAANGs (Meta, Amazon, Apple, Alphabet, Netflix) are getting clobbered in 2022.
Typically, when The Fed prints too much money, such as 10% or higher (red line), inflation follows. Particularly when The Fed prints at 25% YoY in Q4 2020, it was followed by the highest inflation rate in 40 years. But if M2 Money continues to slow, inflation will likely slow, but not to The Fed’s target of 2%.
Despite what Minneapolis Fed’s Neal Kashkari said about The Fed having infinite printing resourses, The Fed is going to fight inflation THAT THEY HELPED CAUSE. Biden’s energy policies (did you see that Elon Musk has a car that uses plentiful hydrogen?), and excessive Federal spending by Biden/Pelosi/Schumer, are culprits in creating the supply chain problems facing America. BUT after the 25% surge in M2 Money in 2020 and 2021, we saw M2 Money VELOCITY crash and burn to its lowest level in history. Which means the “bang for the buck” for printing more money is negligible.
Of course, big tech firms got caught influencing the 2020 Presidential election (see Musk’s release of Twitter files) and engaged in restriction of the 1st Amendment (Freedom of Speech). How much will that impact FAANG stocks going foward?
And yes, the US Treasury yield curve is inverted pointing to a recession in 2023.
And yes, apparently Biden was complicit in the Twitter fiasco.
This will be the last time (Fed rate hikes) as the US economy is forecast to either go into a recession in 2023 or slow down to an anemic 1.20% Real GDP YoY. Even the Fed is forecasting 3.10% core inflation in 2023, still higher than their target rate of 2%.
One of the sectors that is suffering is commercial real estate.
Commercial mortgage bonds could get clobbered in the coming months, and investors are backing away from the securities.
Some $34 billion of the bonds come due in 2023, and refinancing property loans is difficult now. Property prices could fall 10% to 15% next year, according to JPMorgan Chase & Co. strategists. And some types of properties seem particularly vulnerable as, for example, city workers are slow to come back to their offices full time.
That may be why spreads on BBB commercial mortgage bonds have widened by about 2.7 percentage points this year through Thursday to around 6.6%, for the securities without government backing. They are now at their widest since January 2021. They’ve been getting hit particularly hard in the last few months, even as risk premiums on investment-grade and high-yield corporates have been shrinking on hopes the Federal Reserve will scale back its tightening campaign.
“For CMBS investors, there’s lots of uncertainty, especially around whether maturing loans are going to get refinanced or not, and if not, what the resolution will be,” said David Goodson, head of securitized credit at Voya Investment Management, in an interview. “Layering in risk from lower office utilization makes the assessment even tougher.”
The trouble that the bonds face won’t necessarily translate to a surge in defaults in the near term, which is part of why betting against them is so difficult. When property owners can’t refinance mortgages that have been bundled into bonds, noteholders have a difficult choice to make. They can seize the buildings and liquidate them, or they can extend the debt and accept repayment later. They usually go for the second option.
Extending maturities allows bondholders to kick the can down the road and potentially recover more later, said Stav Gaon, head of securitized products research at Academy Securities. The question is whether properties have permanently lost value as, for example, people reorder their lives after the pandemic, or whether declines may be more temporary because of higher rates.
“Foreclosing on a loan, rather than granting an extension, can be really messy — that’s a lesson that was learned during the great financial crisis,” said Gaon. “The lenders also recognize that today’s higher interest rates are a very sudden development that many high-quality borrowers need time to adjust to.”
Some investors that are still buying are focusing on higher-quality borrowers and properties, that are likelier to withstand any downturn in real estate prices without having to seek extensions on loans.
“We think trophy properties will fare better due to better access to the debt markets, lower potential property declines, and a continued tenant flight to quality,” said Zach Winters, senior credit analyst at USAA Investments.
He acknowledges that this strategy isn’t always popular now, even if it turns out to make sense.
“When we go out and bid on a bond tied to a trophy office building now, usually the number of buyers is significantly less than before,” Winters said.
After the Pandemic
The market for commercial mortgage bonds without government backing was about $670 billion as of the end of 2021, and although the securities soared in the second half of 2020 as the Fed opened the money spigots, they’re facing more difficulty now. With office occupancy still below 50% in many cities as more people work from home, corporate buildings may see their values drop. Retail space is similarly under pressure as consumers have grown used to buying more online. And while travel volume is rising, many hotels are struggling to reach 2019 levels for room charges.
A survey of institutional real estate market professionals in November found that firms expect office values to fall about 10% next year, and overall commercial property declines of 5%, according to the Pension Real Estate Association.
The $34 billion of bonds due next year includes mostly fixed-rate CMBS bonds sold without government backing. It’s a steep increase from the $24.4 billion of such bonds maturing this year, according to Academy Securities.
There’s another $103 billion of a type of CMBS known as single-asset single-borrower bonds maturing next year, according to Academy — although most of that debt pile has a built-in contractual ability to extend loans, meaning they’ll be able to seek extensions more easily.
Next year won’t be the first time that CMBS bondholders and servicers have faced tough choices about whether to allow en masse extensions to the underlying borrowers. After the 2008 financial crisis, commercial property values plummeted and many lenders chose to give owners of those properties more time to pay back their loans. As a result they ended up getting more money back than if they’d immediately foreclosed on the loans and liquidated the properties, said Jeff Berenbaum, head of CMBS and agency CMBS strategy at Citigroup.
In terms of watchlisted CMBS loans, currently most of the USA is in the green (good) except for San Francisco, New Orleans, Memphis and Chicago all have elevated commercial loans on the watchlist (loans being watched for going late and into default). Puerto Rico is also in the red (>25%) watchlisted commercial loans, so I expect AOC to be asking for a bailout.
On the office property front, we can see red (>25% of commercial loans watchlisted) pretty much across the board.
The leading metro area in terms of watchlisted office property loans is … Virginia Beach-Norfolk-Newport News VA-NC at 66.49% (that is pretty bad). Providence RI is second and San Juan Puerto Rico is third followed by Charlotte NC in fourth place. The only Ohio city in top 15 is Cincinnati, home of Skyline Chili and Montgomery Inn.
While most are calling for more rate hikes in 2023, I predicted that December’s likely 50 basis point hike with be the last one for a while as the US economy grinds to a halt. Or it’s all over now for Fed rate hikes.
While The Fed predicts slow growth, markets are pointing to recession. The Fed is out of touch with reality. As is the US Secretarty of Treasury, “Too low for too long” Janet Yellen.
The Federal Reserve is removing the massive punch bowl from the US economy and markets. And with the rising US mortgage rates, we got crashing buying conditions for housing.
The UMich consumer survey for buying conditions for house rose slightly in December to 36, well below 100 (the baseline).
The good news for Americans? The global slowdown is helping to lower US Treasury yields which, in turn, helps to help to lower US mortgages rates. Kind of a perverse “good news” story when you think about it.
The bigger picture is the slowdown caused by 1) a global economic slowdown and 2) the tightening of Fed monetary policy to fight inflation.
Look at the Case-Shiller national home price growth YoY (blue line) against M2 Money growth YoY (green line). Just move the green line to the right and it covers home price growth. Both are slowing down with anticipated Fed rate hikes (red line) now at 50 basis points for the December 14th FOMC meeting. And note that The Fed’s balance sheet (orange line) has barely budged.
Unlike Archie Bell and the Drells, this tighten-up is about The Federal Reserve tightening-up its monetary policy.
On December 31, 2021, the US Treasury yield curve (10Y-2Y) stood at +77.4 basis points, generally a good omen.
Then markets woke up. And not in a woke way.
As The Fed tightens to tamp down on inflation in 2022, we are seeing a pattern. The US Treasury 10Y=2Y yield curve has sunk to -82 basis points, a -206% decline.
In addition to the inversion of the US Treasury yield curve we have witnessed M2 Money growth declining -90%, the S&P 50) index down -17.5%, Bitcoin down -64.2% and gold down only -2.3%.
But we now have to worry about Project Cedar, a seemingly innocent project to replace the US Dollar. A new digital currency would allow Washington DC to monitor your purchases and behavior. And perhaps create a Social Credit Score like in China measuring how well you conform to Biden’s notion of a utopian, green society.
And the US yield curve has been inverted for 109 straight days.
The Fed has signaled the terminal rate will likely be around 5% — we think an upper bound of 5% — reached in early 2023. To get there, the central bank will likely raise rates by 50 basis points at its December 2022 meeting, followed by two more 25-bp hikes in 2023. We then see it holding at 5% throughout the year. Markets have priced in a similar amount of tightening.
Controlling inflation comes at a cost to growth. Yield curves have inverted. A Bloomberg Economics model shows a 100% probability of recession starting by August 2023. Take that — like all model forecasts — with a grain of salt. But the basic view that aggressive Fed tightening will very likely tip the economy into a downturn is correct.
While various measures of impending US recession show a good chance of a 2023 recession, Powell’s preferred measure of the yield curve shows only a 30% chance.
What Might the Recession Look Like?
We project a 0.9% GDP contraction in 2H 2023, driven by an investment downturn as firms pare inventories amid a downshift in consumption. Residential investment will also contract with real interest rates likely to rise steadily throughout 2023 as nominal rates stay high and inflation moderates.
An Inventory-Led Downturn
Resilient consumption should help put a floor under demand.
Households have enough of a cash buffer — extra savings built up over the course of the pandemic, rising COLAs for Social Security recipients, ongoing state and local government stimulus and solid 2022 wage income growth — to sustain consumption during the recession. Our base case is for real spending to grow at a quarterly annualized pace of about 0.5% in 2023, with strength concentrated in services.
By one measure, households may still have $1.3 trillion in the coffers, based on flows within the personal income report through September. At the current rate of drawdown, that’s enough to last around 15 months, or through the end of 2023. Funds may dry up faster as job losses mount and the unemployed fall back on their savings.
$1.3 Trillion Extra Savings to Keep Spending Positive
The labor market remained exceptionally tight into the end of 2022. We expect it to soften significantly next year, with the unemployment rate rising to 4.5% by the end of 2023. The pace of hiring will slow markedly as support from catch-up hiring dissipates and the effects of restrictive monetary policy settle in. We estimate only 20%-30% of total employment is still in sectors experiencing labor shortages, implying demand for labor is falling fast.
Avoiding a Hard Landing Depends on Inflation, Fed
Extreme circumstances — the pandemic, Russia’s invasion of Ukraine — have made a recession more likely than not. Extreme circumstances can change, and so can policy makers’ response Whether the US can stick a soft landing depends substantially on how external conditions develop and how the Fed responds.
Not our base case, but we can envision a scenario in which the central bank opts to ease rates in 2023, boosting the chances of a soft landing.
One way that could happen is inflation falling faster than expected. Currently, our baseline is for headline CPI to drop to 3.5% and the core to 3.8% by the end of 2023. The most important assumption there is that energy prices remain flat next year from 2022.
In an alternative scenario, inflation fall faster as China maintains Covid controls and growth stumbles. A Bloomberg Economics model attributes the recent fall in oil prices entirely to a drop in demand — mainly from China. If China’s growth falls off the cliff, perhaps amid a sharp rise in Covid cases and resumed lockdowns, commodity prices could tumble sharply.
A warm winter in Europe and the US could also keep energy prices in check. Lower demand from Europe for US liquefied natural gas would help stem the increase in domestic electricity prices.
In that scenario, US energy prices could fall 20% in 2023 and headline inflation may drop to 2% by the end of the year. Lower gasoline prices would work to soften inflation expectations, easing pressure on the Fed to hold rates at higher level. A rate cut could then come in 2H 2023, raising the possibility of a soft landing.
Scenarios of CPI Inflation in 2023
The risk cuts both ways. A quick and successful pivot to reopening in China could boost oil and other commodities prices. A colder winter in Europe and the US would generate upward pressure for electricity and utility prices. Assuming China is fully open by mid-2023 — the base case for our China team — energy prices could increase by 20% in the year. In that case, headline US CPI would hit a bottom of 3.9% in midyear before surging to 5.7% by year-end.
In that scenario, the terminal fed funds rate would most likely top 5%, possibly closing 2023 near the upper end of St. Louis President James Bullard’s estimated restrictive range of 5%-7%.
Bloomberg Economics US Forecast Table
Thanks to Yellen’s legacy of too low interest rates for too long, The Fed is playing catch-up by finally raising rates.
Confounded Interest - Anthony B. Sanders 
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