Rates Head Higher – Fixed Income Update

Interest rates continued on a gradual climb in January, with rates on key consumer loans including mortgages, auto loans, and lines of credit all increasing. The Treasury yield curve flattened further in January, meaning that shorter term bond yields moved closer to longer term bond yields. The 2-year Treasury bond yielded 1.18% at the end of January, compared to the 10-year Treasury bond yield at 1.78%. Economists view a flat yield curve as the expectation of slowing economic growth.

Mortgage rates rose to their highest levels since the start of the pandemic, reaching a 3.56% average for a 30-year fixed rate mortgage, up from 3.29% at the beginning of March 2020. The 30-year average mortgage rate fell to 2.67% in December 2020, as the Fed aggressively bought mortgage bonds and placed them onto the Fed balance sheet. (Sources: Treasury Dept., Fannie Mae, Federal Reserve)

Equities Experience Bumpy Start to The Year – Domestic Stocks

Optimistic earnings expectations helped to reinforce equities following heightened volatility throughout January. Many analysts posit that recent earnings improvements are merely a result of stimulus-driven growth for some companies. In January, equities saw their worst monthly performance since March 2020, as elevated volatility drove all major indices lower. The only two S&P 500 sectors ending positive for the month were energy and financials, with the real estate and consumer discretionary sectors experiencing the largest pullbacks. However, the 12-month trailing returns through January 31st were positive for all of the S&P 500 sectors. The so-called FAANG stocks now represent 25% of the S&P 500 Index, encouraging some investment managers to reconsider exposure to certain indices with such concentration. (Sources: S&P, Bloomberg)

A Drop In Consumer Savings – Consumer Behavior

Consumers are saving the lowest amount in four years as stimulus assistance funds and generous unemployment benefits have gradually evaporated, encouraging consumers to tap their savings at an accelerating pace. The drop in savings is particularly acute for those nearing retirement. As markets pulled back, so did retirement fund values, extending the retirement time horizon for many. Savings rates rose dramatically in 2020 as billions of dollars in stimulus relief payments made their way into consumer accounts. Federal Reserve data found that households spent only 40 percent of their payments, used 30 percent to pay down debt, and saved about 30 percent on the initial round of stimulus payments. The most recent data show that the savings rate dropped to 6.9 percent in November 2021, lower than where it stood at roughly 7.5 percent before the pandemic began.

Sources: U.S. Bureau of Economic Analysis, St. Louis Federal Reserve Bank

What Is The Fed Balance Sheet & Why It Is Consequential – Monetary Policy Overview

Like any financial entity, the Federal Reserve maintains a balance sheet made up of assets and liabilities. The Fed uses the balance sheet as a monetary policy tool, meaning that it has the ability to cause rates to rise or fall by making adjustments to the balance sheet. The majority of the assets on the Fed’s balance sheet are U.S. Treasury bonds and mortgage bonds, which are critical debt components of the U.S. economy.

Since the Federal Reserve has access to massive amounts of capital, it can buy and sell enormous volumes of Treasury and mortgage bonds in the open market, driving increases and decreases in supply nearly instantaneously. By buying vast amounts of Treasury and mortgage bonds and placing them on its balance sheet, it is essentially removing supply from the markets, causing an increase in bond prices resulting in a decrease in interest rates. Should it sell bonds from its balance sheet into the fixed income markets, then bond prices would fall with rates rising.

The Fed announced that it intends to start shrinking its balance sheet this March. The Fed balance sheet expanded during the financial crisis of 2008, when it starting buying massive amounts of bonds in order to maintain liquidity in a rapidly deteriorating market, while keeping rates low in order to help stimulate economic activity. The size of the Fed balance sheet has grown from $888 billion in mid-2008 to over $8.8 trillion this past month, the largest amount ever. (Source: Federal Reserve)

Consumer Sentiment Dipping – Consumer Behavior Overview

Optimism amid excessive monetary and fiscal stimulus efforts drove consumer sentiment to highs during the pandemic. Numerous stimulus programs provided businesses and individuals with abundant funds in order to help recipients meet financial needs. As of the beginning of the year, the majority of these programs had exhausted benefits and paid out most or all committed funds. As the availability of these funds are depleted, consumers have less to spend and thus feel less confident about future spending. Some consumers have resorted to tapping their savings as unemployment and pandemic benefit payments were exhausted.

Data tracked by the University of Michigan Consumer Sentiment Index revealed that sentiment among consumers has been trending downward since the fall of 2021. The most recent release of the index was 67.2, the lowest reading since November 2011. The index essentially identifies how confident consumers are about spending on various items such as cars, sporting equipment, homes, furniture, and dining out. Index readings were fairly consistent and elevated from roughly 2017 until the start of the pandemic in March 2020. Sentiment improved gradually following the release of stimulus funds in 2020 and 2021, but has since contracted as funds have depleted. (Source: University of Michigan: Consumer Sentiment Index)