Memories of 2007

Wow. That is what I have to say about this week. We saw one of the fastest intra-week rises in the yield (rate) of the 10-year US Treasury. This also pushed mortgage rates to fresh highs. The Treasury yield, as of this writing, is pushing 5.22%.

The last time we were hitting yields significantly over 5% was in the months leading to the turmoil of the Great Recession in June of 2007. That is a period of time most in the real estate industry don’t remember fondly. June 2007 yields hit 5.26%. What caused this spike in yields and interest rates? It is mainly three areas: geopolitical risk (Iran conflict, including comments by both the US and Iranian presidents at the UN), a very strong S&P Global Manufacturing report, and hawkish comments from Fed members.

UN Tensions and Iran: Markets on Edge

The UN meeting this week saw inflammatory rhetoric from both US President Trump and his Iranian counterpart. Both sides returned to a more toned-down level after the speeches. US representatives met with Iran for a “very productive” three-hour discussion. It is clear that the Iranian economy is under incredible stress from the economic pressure the US and its allies have placed on it. It isn’t clear whether this will be enough to move the regime that is founded on ideology rather than politics.

S&P Global Manufacturing: Hot Economy, Hotter Inflation

The S&P Global Manufacturing report showed that the economy was running hotter and contributed to expectations of more Fed policy tightening (higher rates). Manufacturing was reported at 57, much stronger than the 53.6 expected. Services rose to 58.7, also stronger than expected.

There were comments in the report that markets didn’t like regarding inflation: “Price pressures intensified in September. Average input costs measured across both goods and services surged higher, the overall rate of inflation hitting the highest since October 2022.” The report and inflation comments fueled the jump in bond yields and interest rates. Inflation is the arch-nemesis of rates.

Fed Speakers: October Rate Hike Likely

Several Federal Reserve member speakers added to the belief that a hike at their October 28th meeting is likely. Fed futures markets are now predicting about a 66% likelihood of that hike. This is up from 57% last week and from 10% one month ago.

NY Fed President Williams, always a voting member, was one who contributed to this belief. He said it is reasonable to expect another rate hike before the end of the year and that the Fed still has significant work to do on inflation. This hawkish tone was confirmed by Fed Governor Barr and Philly Fed President Paulson.

New Home Sales: Strong Demand, Not Falling Prices

New Home Sales, which measures signed contracts on new homes, rose 6.4% in August to a seasonally adjusted annualized rate of 684,000, much stronger than market estimates of 620,000 and the best number this year. The July report was revised higher by 36,000.

While the median home price has declined about 6% year-over-year, we need to understand that this isn’t due to home price decline but due to the greater number of sales of lower-priced homes. This is called the mix of homes sold. Don’t let the media fool you into thinking this means home values have declined. We follow the Case-Shiller and FHFA Home Price reports to track appreciation and depreciation data. We will see that data on Tuesday.

Rate Outlook: Reasons Not to Lose Hope

Don’t give up hope on rates, though. Even if it is scary to watch rates jump high and very quickly, there are some things that can potentially help us. First, understand that yields look really good to investors. This may see money flow from the stock market to bonds. This buying will likely push yields lower. When yields rise very quickly, this often indicates a coming bear market, slowdown, and/or recession.

All of those are good for rates, while not good for the economy. A potential deal to open the Strait of Hormuz or a return to the MOU previously agreed to by Iran and the US could calm markets.

PCE Methodology Change: Portfolio Fees Removed

Next week could also bring some relief depending on the results of some important reports. One important note is that the PCE report on Wednesday will be the first report to exclude the portfolio management fees from the report. We have discussed repeatedly that this isn’t an inflationary cost and only rises based on the success of the clients’ asset portfolios.

Looking Ahead: Next Week’s Key Economic Reports

There are big reports coming out almost every day:

• Tuesday, September 29: Case-Shiller and FHFA Home Price (appreciation) reports, Job Openings and Labor Turnover (JOLTS).
• Wednesday, September 30: ADP Employment Report, Personal Consumption Expenditures (PCE), Gross Domestic Product (GDP)
• Thursday, October 1: Jobless Claims
• Friday, October 2: September BLS Jobs Report