Stocks are higher this morning after a positive GDP revision. Bonds and MBS are down.
The heads of the Federal Reserve, ECB, Bank of England and Bank of Japan participated in a panel on monetary policy yesterday and Jerome Powell stressed that rates are still going up and will be at these levels for some time. He sees another couple of 25 basis point hikes this year. “We feel there’s more tightening power to do… we believe there’s more restriction coming,” Powell said. A good part of the reason is due to the strong labor market, he said. “Though policy is restrictive, it may not be restrictive enough” and it hasn’t been restrictive for very long, he said.
The point about not being restrictive for long is important. For most of 2022, the Fed Funds rate was well below the inflation rate, which means that real interest rates were negative which is incredibly stimulating to the economy.
The central bankers were asked about how they can increase their credibility to the markets, and Jerome Powell, Christine Lagarde and Andrew Bailey stressed their resoluteness to fight inflation and bring the target back down to 2%. The outlier was Bank of Japan Governor Kazuo Ueda who basically said the BOJ would print more money, which drew chuckles from the crowd. When the panelists were asked to discuss lags in monetary policy, most talked about how some of the rate hikes had yet to be felt. Meanwhile Ueda joked that in Japan, the lag has been decades. The Bank of Japan has been fighting deflation since 1990.
Finally, Jerome Powell said that he didn’t envision the Fed returning to its 2% inflation target until 2025. So, unless there is an economic shock coming don’t look for rate cuts any time soon. The hope for people in the mortgage space is that MBS spreads begin to narrow as volatility subsides in the bond market.
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First quarter GDP was revised upward from 1.3% to 2.0% in the final revision. The increase in real GDP in the first quarter reflected increases in consumer spending, exports, state and local government spending, federal government spending, and nonresidential fixed investment that were partly offset by decreases in private inventory investment and residential fixed investment. The PCE price index was revised downward slightly from 4.2% to 4.1%. The core rate, which excludes food and energy was revised downward from 5.0% to 4.9%.
In terms of industries, health care / social assistance was the biggest contributor to GDP while finance / insurance was the biggest laggard.
The Federal Reserve released the results of its stress tests for the US banking sector yesterday. They showed that the top 23 banks have sufficient capital to absorb a half a trillion hit and still extend credit. While many banks have unrealized losses on their investment portfolios, the scenarios envision falling interest rates, which will reverse some of these losses.
Interestingly, the report didn’t mention Silicon Valley Bank or Signature Bank. The stress tests didn’t envision the scenario we had earlier this year when rates would rise in an inflationary environment.