Central Banks Tighten

Keeping in mind that slower economic growth and lower inflation are favorable for bonds, a wide range of major economic news this week was mostly positive for mortgage rates. Both the US Fed and the European Central Bank announced the expected rate hikes this week and emphasized the need for additional tightening, perhaps even more than investors had anticipated. In addition, the latest inflation data was lower than expected and consumer spending came in below the forecasts. As a result, mortgage rates ended the week lower.

At the meeting on Wednesday, the Fed raised the federal funds rate by 50 basis points to a target range of 4.25% - 4.50%, the highest level since December 2007. Investors immediately focused on the latest projections from officials for the terminal (peak) rate which increased to 5.10%, above the investor outlook of around 4.90% prior to the meeting. During his press conference, Fed Chair Powell remained firmly committed to fighting inflation but appeared to leave the door open if inflation were to decline unexpectedly quickly. While noting that it will take "substantially more evidence," Powell hinted that the Fed would be willing to scale back its monetary policy tightening if the data convincingly indicates that inflation is on a "sustained downward path." The European Central Bank (ECB) also raised benchmark rates by 50 basis points and delivered a similar message about doing whatever it takes to bring down inflation. 

Consumer spending accounts for over two-thirds of US economic activity, making it an important indicator of the health of the economy. In November, retail sales fell 0.6% from October, well below the consensus forecast for a decline of just 0.3%. The pullback was widespread, and particular weakness was seen in furniture stores, building materials, and auto dealers. This report increased investor concerns about a slowdown in shopping due to higher prices and economic uncertainty heading into the crucial holiday season.

From the point of view of a bond investor, the events this week painted a pleasing picture. The annual inflation rate has been dropping more quickly than expected over the last couple of months. In addition, the significant decline in consumer spending suggests slower economic growth, which would reduce future inflationary pressures. Finally, central bank officials remain firmly committed to additional monetary policy tightening to further restrain the economy and bring down inflation.