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Market Update

From the Desk of Jason Obradovich, Chief Investment Officer

Inflation Is Here

Hello, everyone, and welcome back to the Mortgage Rundown. Today, we're going to talk about what's happening with interest rates.

So, by now, you know, the FOMC met and didn't do anything. So why did mortgage rates actually go up? They didn't raise rates, but they did come out and say they are going to raise their inflation expectations. And as you might know, if you have an interest rate or a fixed-income security and inflation goes up, you're actually going to see a deterioration in value. Why would I want to own something that has a 1.5% yield? And all of the sudden now inflation is 4 or 5% and maybe even higher.

And so, what the Fed did was something very subtle, but very important, and that was to raise that inflation forecast. And almost more importantly is they came out and said, “look, we're also going to move up when we actually expect to raise interest rates in the future to 2023—if you own a mortgage-backed security, right? What goes into mortgage-backed security? Mortgages. What's the length of time of a mortgage? Most of them are 30 years. So, if the Fed is going to be raising rates sooner and you have this fixed-interest earning asset for 30 years, now, all of a sudden it’s going to be worth less and less or the perceived value is going to be worth less and less.

And so that's why yesterday when the Fed came out with the announcement, even though they said, “Look, interest rates are unchanged,” it does have an impact on mortgage-backed securities where rates are actually going to move higher.

But this is the first step of them saying, “we're going to be raising rates at some point. It's just not right now. We're going to let inflation last for at least the time being, for the end of the year, maybe even to next year, because there are these other risks.”

We have the pandemic. I think, by and large, most people believe the pandemic is kind of moving behind us. But what happens if there's another variant, right? What if that causes some type of shutdown or localized shutdown because of a variant? Right? That could be a real risk. Well, unemployment rate, you know, I'll put up on the screen for you. You can see where our unemployment is. Unemployment skyrocketed during the pandemic, is coming down, but is nowhere near the levels of where they were before the pandemic.

And so, in summary, what the Fed has said is, “Look, we expect inflation in the short term to continue. We're going to let it happen. It could be even larger than what we anticipated. And we're also expecting the recovery to come sooner and therefore, we're going to raise rates even sooner than what we anticipated.

 

Now, that's their projection. But really, by and large, I think that is probably close to reality. And so, if you're really looking at mortgage-backed securities, you have to be weary of the fact that those values are going to deteriorate if inflation stays high and the Fed raises rates sooner than later.

 

All right, everyone, that's it from the Capital Markets Desk this this week. Take care and have a great day.

 

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