The Federal Reserve will announce its latest decision on interest rates and its outlook for the future. The consensus is that the Fed will not cut rates this time and that there may only be one or two cuts in 2025. Some are betting on no cuts.
The Fed's actions will have repercussions for the markets and the real world.
The bond market is betting on no rate cut and seems to be happy about it as keeping interest rates at current levels could slow inflation further. Tomorrow we will get the latest Personal Consumption Expenditure Prices (PCE) release. This is the Fed’s favorite measure of inflation and the widely watched core PCE is expected to rise at a 2.5% pace compared to a 2.2% rise in the prior month.
That means that the market has already priced in a steady rise in inflation, albeit at a slower pace than what we’ve seen in the past. Recent PMI data suggests that inflation is not falling and that it may be accelerating. Also on deck is the latest GDP number which is expected to clock in at a 2.7% year over year rate.
The bottom line is that the market is expecting the inflationary grind to continue while the U.S. economy muddles along. That means that any deviation from expectations will be a market moving event. A hot PCE or a stronger than expected GDP will likely hit the bond market and yields which have been dropping lately will likely drop. The flip side is that no surprise or softer than expected numbers could push bond yields lower.
Bonds and Mortgages
Ahead of the FOMC announcement this afternoon, the U.S. Ten Year Treasury Note yield (TNX) is hovering near 4.5%. Yet as the long term chart shows, TNX is just above its 50-day moving average but is still well within the striking range of its recent highs which correspond to the upper Bollinger Band (BB - green line) which is two standard deviations above the 200-day moving average. This is a highly meaningful configuration of the BB and a moving average as moves within this range describe the long term “normal” distribution of yields. Anytime TNX rises above the upper BB, or fall below the lower BB in this configuration, it usually leads to a meaningful reversal.
For their part, mortgage rates are hovering near 7%, a number which has in the past slowed housing activity. This week’s mortgage data on all fronts proves that as it has flattened out.
In the Real World
In my usual exploratory rounds, I’ve seen a steady pickup in activity. There are lots of lookers, but I’m not seen any buyers. That means that price, and the attached mortgage payments are still the major drivers affecting potential buyers.
On the other hand, newly built apartments are slowly attracting tenants as previously empty parking lots are starting to fill up.
The Homebuilders Have Bottomed. Patience Will be Required.
The homebuilder stocks are a value haven for investors as many are trading near their recent lows even after hitting bottom a few weeks ago. Many are selling at less than 10x earnings with recent financial reports admitting to flat sales and murky outlooks while supply and demand remains in favor of the homebuilders.
The iShares U.S. Home Construction ETF (ITB) is just below its 200-day moving average which coincides with a large VBP bar, making the $112 price point doubly important. The response to the Fed’s actions and comments by bonds will likely move ITB. We’ll see how that develops.
I’ve been nibbling at the homebuilder stocks for the past few weeks in my Smart Money Passport, featuring shorter term trades and my Weekender Portfolio aimed at patient investors, while expecting any payoff to be well into the future unless there is a major softening in interest rates that lasts.
The iShares U.S. Real Estate ETF (IYR) has outperformed ITB over the last few weeks, reflecting the market’s perception of high home prices leading potential homebuyers to rent. This is well confirmed by my observations above. As with ITB, the bond market’s response to the Fed will likely move IYR.
Bottom Line
The FOMC meeting and the bond market’s response will affect the short term trend in homebuilders and REITs as well as the action in the tangible (real world) housing market.
On the ground there is increasing interest in buying homes where supplies remain tight and demand remains high. Prices and mortgage rates remain too high for many which are opting to rent.
Homebuilders are likely to remain profitable due to adjustments in their business models such as incentives, the building of smaller houses, and focusing on building homes in areas where demand is highest such as the Sunbelt, areas of the Northeast, and the Midwest.
The financial markets and the real world seem to be in synch. Thus, any temporary improvement in interest rates will likely have a positive impact on home buying. As we’ve seen over the last year, however, any positive effect may be limited to how long rates remain attractive.
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