Good Tuesday PM from your Hometown Lender,

Some interesting data out today.

The Richmond Fed manufacturing index came in at -19 and worse than expectation but the Consumer Confidence came in much better. It seems the consumer is less concerned about the economy than they were (and in my opinion, should be). The latest 24Q3 GDP estimate from the Atlanta Fed is 2%, down from 2.9% a week ago. Similarly, the NY Fed sees 1.8%, down from 2.2%, and the St. Louis Fed sees 1.3% growth, down from 1.6%. Averaging the three suggests 24Q3 GDP growth will be a weak, non-inflationary, 1.7%. Mortgage Bonds are outperforming their big brother the 10-yr treasury today. Mortgage bonds are at the highest they have been since April 4th, 2023 and I think they will continue to improve.

Interesting piece on interest rates below… Be cautious and don’t expect too much from the Fed.

The Fed is almost certainly going to start cutting interest rates in September, and generally that’s seen as good news for individuals and businesses that seek to borrow money. You know, would-be homebuyers, real estate developers, clean energy companies (Matt Zeitlin at Heatmap News has a good piece on that here), and so forth.

And of course, all things being equal, yes, the Fed cutting rates does benefit borrowers. But, a few notes of caution.

For one thing, borrowing costs have already come down substantially. The average 30-year mortgage was over 8% in late 2023. Today it’s under 7%.

Of course, one component that goes into the pricing of a mortgage (as well as any other kind of long-term borrowing) is the yield on US Treasuries. The 10-year yield has already come down a lot, from roughly 5% last October to sub-4% today.

What’s important to bear in mind is that what the Fed controls directly is the overnight cost of funding.

What matters to most people and business or individuals is not the overnight cost of funding, but long-term funding costs. And the way to think about long-term funding costs is that the long-term is just a long series of short-terms. So one basic way to think about the yield on a 10-year Treasury is that it reflects what the market believes that short-term rates will average out to over the next 10 years. As for what will determine the average overnight interest rate for the next 10 years… well it’s whatever the Fed has to do to keep inflation at 2%.

If the rest of this decade is the reverse image of the 2010s, and we keep getting upside inflation surprises, then the Fed may feel that it can’t cut rates very deeply while staying consistent to its mandate. As such, the market could continue to price elevated 10-year yields (elevated, at least, relative to pre-Covid levels). If we get a recession, or a productivity boom, or some other sustained disinflationary trend, then of course the market might price lower rates.
So ultimately, if you want to see lower rates, it doesn’t matter too much if the Fed cuts 25 basis points or 50 or what it does in the next month. What matters is the general trajectory of inflation, for the lower that goes, the lower the Fed can reduce interests. And of course, if the Fed cuts too much, and causes the economy to reaccelerate and heat up again… well then one can easily imagine a scenario where today’s rate cuts mean higher yields on long-term Treasuries and higher borrowing costs for firms and individuals going forward.

Stay safe and make today great!