Rates & Market Volatility

A: I feel the need to briefly discuss the resilience of US equities in response to the plunge in Chinese stocks yesterday. When the fed minutes were released yesterday, it showed that the gov't body in control of monetary policy saw less risks to the US economy but inflation remained above expectations. The markets for some reason interpreted this that the fed would still consider cutting interest rates by years end if bad news hit OR that the economy is stronger than expected; both good news for stocks and hence the rally.

Well, when I was a trader I focused more on volatility, short term trends, and which market makers were supporters or dumpers of a particular stock to take advantage of quick movements (if Morgan Stanley had a huge buy order in QCOM, I would see it and follow the leader). Now that I'm out of trading and in real estate, I shifted my focus to understanding the economy, what affects monetary policy, global issues, inflation, etc..One thing that has never changed is there are times where I just don't get what stock traders are thinking?

Now is one of those times. I don't get the rally yesterday. Yes, the fed sees less risks to the US economy via stronger data points (strong jobs & manufacturing) but why would the street interpret this to mean future rate cuts are in the works? If the economy has less chance of going into a recession and fed focus remains on curbing higher inflation, how does that equate to lower rates?

According to CNN Money article titled, "Fed: Risks to Economy lessen":

The Federal Reserve at its May 9 meeting believed inflation was still the main threat to the economy but also said the risk of an abrupt slowdown in economic growth had diminished, minutes released Wednesday show.

"Members continued to view the risks to economic activity as weighted to the downside," the minutes said.

Policy-makers thought turmoil in a segment of the U.S. mortgage market would not spread more broadly and saw signs that sluggish business spending was reviving.

As a result, "these downside risks were judged to have diminished slightly," they said.

At the same time, nearly all of the policy-makers continued to believe that inflation, excluding food and energy, was "uncomfortably high" and should come down more.

What you need to know is that the fed reported a stronger US economy, less risk of a recession, and still higher inflation. All this combined to keep 10YR bond yields higher, providing NO relief on the mortgage markets. The street is now interpreting both good and bad news as GOOD NEWS, a clear sign of a bull market. If the economy starts to slow, then the fed will consider cutting rates: GOOD NEWS. If the economy powers ahead and shrugs of housing and Int'l selloffs: GOOD NEWS. There is always a disconnect with rational thinking and stock market psychology.

What I see is: Record stock prices, Int'l stock bubbles, Housing downturn, GDP growth slowest since '02, High energy prices, and higher rates, tighter loan standards.

What is keeping US stocks hot: M & A activity, corporate buybacks lower P/E ratio's, weak dollar boosting profits, globalization, corporate management discipline, tons of liquidity, low interest rates starting to rise

In any event, the US shrugged off the China selloff and interpreted the fed minutes as a positive in less chance of a recession. That means higher bond yields. As stocks rise, bond prices fall (yields rise). Expect lending rates to trickle higher with the markets reaction over the past 2 days!

How this ultimately affects affordability and housing remains to be seen but you can bet on one thing: LENDING RATES WILL TRICKLE HIGHER as the 10YR Bond yield moves past 4.917%!

Oh boy, I would really keep tabs on mortgage rates and the 10YR bond yield to see if this upward trend continues past the all-important 5% mark! It's hard to argue the effect higher mortgage rates have on the housing market and heading into the summer months now is NOT the time for lending rates to take a sharp move higher; but it appears to be a good possibility. Unless we get some negative economic news to reverse this course, expect rates to trend higher.

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