Mission: Near Impossible

Issue 309

By Jeffrey Trusheim, Chief Financial Officer, Mortgage Solutions of Colorado, LLC DBA, Mortgage Solutions Financial.

Mortgage Solutions presents Issue 309 of Market Pulse. This commentary will provide Trusheim's perspective of the economic, political, and technical considerations that will have an impact on the global & domestic financial marketplace. The report will provide a recap of the previous week's activity as well as a look at the important market-moving factors in the week ahead.

The monthly reading of consumer prices was released last week and it continues to show that inflation remains sticky, and well above the Fed’s 2% target. The Consumer Price Index (CPI) for September came in at 3.7% Y/Y, down from the pandemic-era inflation peak of 9.1% in June 2022. Stripping out the volatile food and energy prices, core CPI rose at a 4.3% annual pace, leaving the possibility of additional interest rate hikes squarely on the Fed’s table.?

Minutes from the FOMC September meeting indicate that Fed officials see “restrictive” policy staying in place until inflation eases. “A majority of participants judged that one more increase in the target federal funds rate at a future meeting would likely be appropriate, while some judged it likely that no further increases would be warranted.” All voting members of the committee agreed they could “proceed carefully” on future decisions, which would be based on incoming data rather than any preset path. Since the September meeting, the 10-year Treasury note yield has risen about 25 basis points, in effect pricing in the rate increase FOMC members had indicated was coming.?

The Fed has been left with a near-impossible task. They are trying to come up with a solution that measures the right amount of restraint needed to bring inflation back down to target while keeping the economy and consumers from getting destroyed in the interim. We have already seen the effects of above target and sticky inflation. Higher prices across the entire spectrum of goods and services - gasoline, housing, rents, cars, hotel room rates, flights, and restaurants. And the Fed’s aggressive hiking has put mortgage, auto, and credit card rates at multi-year highs.

Considerable progress has been made with the Fed’s 525 basis points of rate hikes bringing inflation down from around 9% to around 4% since March 2022. However, the Fed is determined to get inflation back to the 2% target and does not expect to get there until 2025. Meanwhile, interest rates are likely to remain near current levels, or even move a little higher, depending on the inflation data in the months ahead.?

Bottom line: With inflation likely to remain “higher for longer”, we should expect the Fed’s monetary policy to keep interest rates high (or higher) for longer as well. However, I would expect the debate to soon shift from “how high” to “how long”. Those who continue to expect rate cuts anytime soon will continue to be disappointed. Short of a severe recession, the Fed will likely keep their foot on the brake until inflation stabilizes (for a time) at their 2% target. IMHO, the first rate cut is probably a year away.?

HOUSING

The Mortgage Bankers Association reported weekly loan applications were up very slightly week-over-week, but are just off last week’s three-decade lows. With mortgage rates extremely high, demand for borrowing is curtailed even as inventories remain extremely tight. The result is a severe slowdown of mortgage borrowing, as well as a?slowdown of new supply coming to market. At least the new homes that are hitting the market aren’t being impacted by the desire to stay in a low-rate mortgage which has hit existing home supplies. But with 30-year fixed-rate mortgages hovering around 8% recently, even the new home market is struggling amidst major concerns for affordability.?

The average monthly payment on mortgages is up over 70% since 2019. The average home in America costs about $400K, and the monthly mortgage payment on that $400K home has increased by about $1K during the last two years. In 2020, a $1K monthly mortgage payment could buy a home priced at $309K. Today, that $1K monthly mortgage payment will buy a home priced at just $173K. The silver lining is that it appears we are at or very near a peak in mortgage rates, and home listings and price reductions are popping up all over the internet sites like Zillow and many others.?

THE STOCK MARKET

There is an old and widely used market axiom that goes: History may not always repeat, but it usually does rhyme. The seasonal tendency for early September through early October to be the worst time of the year was right on the money this year. The S&P 500 had a September 1st high of 4541, and an October 3rd low at 4216, producing? a 325 point near vertical decline. And from the late July high at 4607, the S&P has declined nearly 400 points. We caught that nicely, and thankfully it has passed. Seasonally, we are approaching the strongest time of the year, with the annual Santa Claus rally just weeks away. ?

We are in the midst of Q3 earnings season, with caution in earnings outlooks quite prevalent. With the bar set rather low, there is an increased probability that we could see some upside surprises. The earnings outlook for 2024 currently has a Consensus view at $248 for the S&P 500. If the S&P 500 maintains it’s current 20X multiple next year, the fair value would rise to a new all-time high at 4960. Goldman Sachs, the premier investment bank on Wall Street, has the S&P 500 earnings at $237 next year. That would produce a fair value at 4740. Our technical target is smack in the middle at 4800.

The trading pattern for the S&P 500 last week had a low on Monday at 4283, a high on Thursday at 4385, and a close on Friday at 4327, up 19 points on the week. Not too shabby when you consider: a new war breaking-out and higher-than-expected readings on retail and wholesale inflation. As mentioned in previous missives, the battle lines are drawn and the technical parameters are clear: Above 4401 confirms a bottom and targets an eventual test of 4800 in the months ahead. Below 4165? opens a trap door which targets a test of the October 2022 low near 3500.?

The S&P 500 made four valiant attempts (Tuesday thru Friday) to penetrate overhead resistance at 4401, reaching levels in the 4377-4385 region, but was turned away each time. Support begins at Friday’s low at 4311 and extends lower to 4282. I will be looking to add to my positions in this range, and raise my stop-loss level to 4275 for risk management purposes.

For every near-term positive, I can also show you a near-term negative. This is a bifurcated market loaded with uncertainty, and not for the faint of heart. Be careful.?

THE BOND MARKET

It was another wild ride at the Ole Bonderosa last week. The 10-year Treasury yield opened at 4.61% on Tuesday morning and proceeded to grind higher to 4.72% by Thursday morning (CPI report), but then plummeted to 4.53% on Thursday afternoon (yes, a 19 basis point intraday plunge), then surged to 4.69% on Friday, before finishing the week at 4.61%, down 18 basis points on the week. The “Bond Vigilantes” were handing out Dramamine! I must admit, the bond market volatility was making me dizzy.

The rapid surge in yields from 0.50% during the pandemic to the recent high near 4.90% has produced losses on long-dated Treasuries that rival some of the most notorious meltdowns in U.S. history. The 10-year Treasury has lost about 46% since peaking in March 2020. The 30-year Treasury has tumbled 53%, nearing the 57% slump in the equity market during the depths of the 2008-2009 financial crisis.?

Last week, market probabilities for a rate hike at the November 1st FOMC meeting jumped to 31%, but a hike at the December 13th meeting declined to just 17%. So, odds for one additional rate hike remain near 50%. IMHO, the bond market and the yield curve have done the heavy lifting for the Fed, possibly negating the need for additional rate hikes. Of course, the Fed will continue to be data dependent…and so shall we.

But, when you do the bond math, the risk/reward for duration is very favorable right now. Just a slight decrease in yields from here could give you an extraordinary return, whereas a slight increase in yields won’t cost you much. A 50bp decrease in yields would produce a 8%+ return, where a 50 bp increase in yields would cost about just 1%, when doing the math on the 10-year Treasury at 4.60% current yield. I can see the 10-year yield dropping to 4% within the next two years.

FINAL THOUGHT

The world changed last Saturday - and it was yet another dramatic change for the worse. In a barbarous terrorist attack, thousands of Israelis and dozens of Americans were lost. Men, women, children, and babies executed in the most ruthless and despicable manner imaginable. It’s being called “Israel’s 9/11.” I offer my sincere condolences and total support for Israel. My thoughts and prayers are with those who lost their lives and their families who are suffering.

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Have a great week!

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Jeff Trusheim is the CFO of Mortgage Solutions Financial. Jeff is a 30+ year veteran in the Wall Street arena, with a background in economics, risk assessment and finance (banking and mortgage). He has previously worked in Fortune 500 companies in growing their portfolio and economic footprint.