Did we just experience the mother of all head fakes in the bond market?

The last couple of weeks had a pretty dramatic move lower in bond yields. The “higher for longer” narrative has been replaced by investors pricing in further rate cuts next year. Sentiment seems to hang on every word out of the Fed and each individual piece of economic data. We have so many conflicting signals about the economy that it seems like everyone has a story they can spin from the data. Given that 2024 is an election year, these takes include a lot of partisans talking their political book, and a lot of strategists who got some macro bets wrong.

At first glance, the rally in the bond market might seem like asset allocation trades - people that missed the rally over the past month and were deeply underweight Treasuries going into the end of the year. Now they are catching up, and that is increasing demand for Treasuries. Have we just gone through the mother of all headfakes in the bond market last September and October? If so, a lot of people were caught offsides.

Last Friday, we got the jobs report, which showed the economy created 199,000 jobs in November, while the unemployment rate fell from 3.9% to 3.7%. This report got the “soft landing” crowd claiming victory, while causing investors to trim 2024 rate cut bets. The jobs report was affected by returning UAW and Hollywood strikers, and wage growth remained robust at 4%. We also saw improved consumer confidence numbers, which is probably being driven by lower gasoline prices. Food on the other hand is a genuine source of heartburn, especially for fast food prices. Since labor costs are a big part of fast food pricing, increased wages are showing up in prices. Plenty of memes and videos abound on social media with young people griping about prices.

Washington is well aware of the issues concerning house prices. Congress is considering a bill that would ban hedge funds and private equity firms from owning single family rentals. There was this story going around claiming that private equity accounted for 44% of home purchases in 2023. That number is garbage - investors purchased about 15% of all existing homes in October, and that includes a lot of individual investors along with hedge funds.

The biggest publicly-traded single family REIT is Invitation Homes which owns about 80,000 properties. Competitor American Homes 4 Rent owns another 59,000. Sure, Blackrock funds own some as well, but institutional investors are not driving up home prices and making them unaffordable. My sense is the Congressional Bill is a way to say Washington cares about home affordability, but this won’t actually help affordability. It takes out one marginal buyer.

The problem of housing affordability can be fixed most easily by lowering interest rates. The supply / demand imbalance can’t support falling prices, outside of some individual MSAs, and falling house prices is generally a disaster economically.

The Biden Administration is considering low cost loans to developers to build affordable housing in blighted neighborhoods. Given that construction costs are high at the moment, if the loan comes with rent control attached, it probably won’t get many developers to take the bait.

Coming up, we have the December FOMC meeting coming up this week. The markets are betting that the Fed maintains rates at current levels. That said, the bond market bets for a recession increased as the Fed Funds Futures bumped up expectations for rate cuts next year. The March Fed Funds futures are now pricing in a 45% chance of a rate cut.

We will also get the Consumer Price index on Tuesday. The Street is looking for no change on the headline number, and a 0.3% increase in the core rate. Year-over-year, the headline rate is expected to increase by 3.1% and the core rate is expected to increase by 4%.

Monday’s 10-year Treasury auction wasn’t as bad as feared, but government bond supply continues to be an issue. Investors are concerned about the 30 year auction on Tuesday, given that the last 30 year auction was a disaster.

The action in the bond market this week will be driven almost entirely by the new Fed dot plot. As of September, the Fed saw the December 2024 Fed Funds rate right around 5%, which would indicate barely any rate cuts in 2024. The Fed Funds futures see the December 2024 Fed Funds rate around 4%. The Fed is understandably loath to start talking rate cuts yet, but their hand might be forced by political pressure, a weakening economy and affordability constraints in housing. Since the government can’t do much about housing affordability directly, it will fall to the Fed to do the heavy lifting.