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What if, instead of cutting rates three times this year to help a slowing economy achieve a “soft landing,” Fed policymakers see inflation continue to be higher than they expected and eventually raise rates?
Analysts at UBS Group AG said this week that this was not their base case scenario, but if a “no landing” scenario materializes, mortgage rates could surge above 8% next year and send the stock market into chaos.
“If the economic expansion remains resilient and inflation slides into 2.5% or higher, the Fed will There is a real risk that the Fed will raise interest rates again early next year.
UBS, which previously expected the Fed to cut interest rates by 2.75 percentage points this year, now expects only two cuts of 25 basis points, totaling a paltry half a percentage point. Bloomberg News report.
This is UBS’s baseline scenario. The worst-case scenario is that inflation continues to exceed expectations, and the Fed instead raises interest rates by a full percentage point, raising the federal funds short-term borrowing rate to 6.5% by mid-2025.
Michael Contopoulos, director of fixed income at Richard Bernstein Advisors, said the chance of the Fed raising interest rates could have a significant impact on lenders and stock market investors, regardless of whether it actually happens. Tell Yahoo Finance.
“I think a rate hike is unlikely, but I think the market will start to price in a rate hike,” Kontopoulos said.
Currently, the futures market still sees zero chance that the Fed will raise interest rates rather than cut them.this CME Group Fed Watch ToolOn Monday, the agency, which tracks investor sentiment to assess the likelihood of future action by the Federal Reserve, put the likelihood of a hike in the federal funds rate in June 2025 at 0%.
Investors estimate that by June 2025, there is less than a 2% chance that Fed policymakers will maintain the current federal funds target rate of 5.25 to 5.50, and the possibility of one or more interest rate cuts is 98%.
However, as inflation data continues to heat up, investors in the futures market currently believe that the probability that the Federal Reserve will cut interest rates one or more times in June this year is only 22.5%, down from 59% a month ago.
Meanwhile, mortgage rates have regained much of the ground lost to bond market investors who fund most home loans last year.
Rates on 30-year fixed-rate loans rose back above 7% last week after falling from a 2023 peak of 7.83% recorded on Oct. 25 to a 2024 low of 6.50% on Feb. 1, according to loan lock-in data tracked. Nice blue.
Mortgage rates could continue to rise this week 10-Year Treasury Bond Yield It surged 13 basis points on Monday after stronger-than-expected March retail and food service sales data.
The Census Bureau said retail and food service sales increased 0.7% from February to March and were up 4% from a year earlier to 7,096, after adjusting for seasonal changes but excluding inflationary price increases. One hundred million U.S. dollars. report.
Dip into the “30-10 spread” glimmer of hope
Source: Optimal Blue and Federal Reserve data Retrieved from FREDFederal Reserve Bank of St. Louis.
While the 10-year Treasury yield is a useful barometer of where mortgage rates will go next, one piece of good news for those worried about rising borrowing costs for homeowners is the ” 30-10 spread” notes have eased.
The spread, which averaged two percentage points before the pandemic, soared to more than three percentage points at times last year as investors demanded higher returns on mortgage-backed securities (MBS) than on Treasuries.
Part of the reason the 30-10 spread has grown is that, with the Fed expected to cut interest rates in 2024, MBS investors are beginning to demand higher returns to compensate borrowers for being more likely to refinance earlier. Repayment risk increases.
To ease the burden on mortgage borrowers, real estate and lending industry groups last year pleaded with the Fed to stop shrinking its massive MBS portfolio to narrow interest rate spreads. The groups said the Fed could buy new mortgages to replace maturing assets, rather than letting $35 billion in MBS be written off every month.
After the Fed’s last meeting, Powell said the central bank was preparing to slow down the pace of “quantitative tightening” of its balance sheet. But with mortgage rates still too high to provide homeowners with an incentive to refinance, the Fed can only cut its MBS holdings by about $15 billion per month, less than half of its $35 billion monthly target.
However, the 30-10 spread is already narrowing as expectations for a sharp rate cut from the Fed fade. The spread averaged 2.87 percentage points last year and 2.58 percentage points this year. It fell below 2.50 percentage points twice in April, a threshold that has not been exceeded since June 2022.
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