A lawyer meets with the family of a
recently deceased millionaire for the reading of the will.
"To my loving wife, Rose, who always
stood by me, I leave the house and $2 million," the attorney reads.
"To my darling daughter, Jessica, who
looked after me in sickness and kept the business going, I leave the yacht, the
business, and $1 million."
"And finally," the lawyer
concludes, "to my cousin Chet, who hated me, argued with me, and thought I
would never mention him in my will. Well, you were wrong. Hi Chet!"
Yesterday, to to the surprise of no one, the Federal Open Market
Committee voted to increase rates. This 25 basis point increase in Fed Funds,
of course, has a ripple effect around the world, including "emerging"
markets. As economist Elliot Eisenberg put it, "Rising rates, and thus
improved US returns, vacuum up money from developing nations, causing their
currencies to decline. This forces those nations to consider raising interest
rates to reduce inflation and protect their weakening currencies."
Although economic activity is still expanding at a moderate pace, the FOMC
statement acknowledged that conditions in the labor market, as well as
expectations for slightly accelerating inflation, warrant the increase.
Moody's (the rating agency) expects the loosening of
underwriting standards for residential mortgages as borrower demand drops off.
"We expect the equilibrium federal funds rate to converge around 3.0% and
the 10-year yield to settle around 4.0% within the next five years."
Rising interest rates will have varied implications for US
structured finance sectors. Overall, US consumers are well-positioned to cope
with rising debt expenses given the current stable macroeconomic environment
and generally strong household balance sheets, which will result in neutral or
slightly negative credit effects on consumer asset classes including
residential mortgage-backed securities (RMBS).
In this country, the yield curve flattened after the news.
The spread between 2 and 30-year Treasuries (the traditional measure of the
steepness of the yield curve) narrowed sharply (-7 basis points to 189 bps) as
traders began truly thinking about 2017. The verdict is a more
"hawkish" Federal Reserve in 2017, meaning more aggressive in raising
rates: the Fed anticipates three .250 rate hikes in 2017; a few days ago
the markets were expecting two.
The Fed's decision can affect the cost of housing, cars,
student loans, credit cards, etc. When the Fed raises rates, all sorts of other
expenses eventually tick up. In theory movement of the Fed's rate does not have
a large, direct impact on long-term mortgage rates. But when the Fed's rate
goes up, banks find ways to pass their higher borrowing costs along to
consumers. And the fact that the Fed thinks the economy is strong enough to
warrant higher rates can lead to higher rates. Long-term mortgage rates
factor in the anticipation of future rate increases. That's part of why
mortgage rates have been shooting up in recent months: The Fed has suggested
that interest rates are likely to continue rising for years.
(An interest-rate increase may also affect renters - just not as
directly. Higher rates mean that landlords must pay more to purchase and
renovate their properties, so in the long run, those are costs they could
easily pass on to renters. But with the labor market improving, workers' wages
could rise at about the same time and pace as rent prices.)
Looking at mortgages, analysts are talking about, once
again, the tapering of MBS purchases could occur before the end of 2017, sooner
than expected, should the Fed's forecast hold true. But for now the NY Fed will
continue to buy $1-2 billion a day of agency MBS - which given declining
applications means that $1-2 billion, as a percentage of daily volume, is more
significant. The Fed will have less money to buy MBS as fewer loans prepay...
By the time the dust settled the 10-year T-note was yielding 2.52%, and 5-year
notes and MBS prices had worsened .375.
Not that they matter much but today we've had the November
Consumer Price Index figures (+.2% headline and core), December Empire State
Manufacturing Survey ("9"), Philadelphia Fed Business Outlook Survey
(higher than expected) and Initial Jobless Claims (-4k to 254k). Coming up is
the NAHB (builders) Housing Market Index. The 10-year is yielding 2.60% and
agency MBS prices are worse .250 versus last night's close.
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