A surprisingly strong jobs report on Friday got a lot of media attention for pushing interest rates up, and interest rates did indeed take a bit of a jump up on Friday. But if you take a look at the chart below you’ll see they’ve actually been rising sharply for two weeks. We can ask two questions:
- What happened? (And why?)
- What is likely to happen in the coming weeks? (And why?)
Let’s start by reminding ourselves that interest rates tend to jump up on news stories, and settle down as the impact of those stories are carefully considered.
Remember that interest rates are set by investors who buy securities backed by mortgages. These investors have to anticipate what inflation will be in the future. (If they earn less on their money than the inflation rate, they are getting back dollars that are worth less then they invested.)
Consequently, they are always looking ahead for signs of potential inflation. Most of the major economic reports this week were unsurprising; all of them came out at right about where economists had predicted, and most were slightly negative or neutral. The only strongly positive exception was non-farm private sector job growth (271,000 compared with 180,000 expected.)
Why is this important? If more folks are employed full time then inflation could be a problem in the future, as families begin to spend again and compete for goods and services, thus driving demand for goods up, and putting pressure on prices.
The other side of the price equation is supply, so another important economic report is the cost of labor, known as Unit Labor Costs. This rose by 1.4% (annualized, and adjusted for inflation.) If the cost of producing goods goes up, businesses have to raise prices.
This pressure can be mitigated somewhat, however, by increased productivity; if your workers earn more but also produce more the cost of production doesn’t rise that much, or maybe at all.
Productivity, it turns out, increased at a 1.6% annual rate in the third quarter, but it was expected to decrease by 0.2%. This comes on top of a second-quarter rise in productivity at a 3.5% annualized gain. In other words, American workers are making surprising gains in how much they produce for each hour they work.
At the same time, hours worked fell in the third quarter by 0.5%. (If workers produce more you can send them home earlier.)
What does all this mean?
More people are employed, and they are earning more per hour. (Yay, but that’s inflationary.) However, they worked fewer hours on average and produced more goods. (Bummer, and yay, but those both mitigate inflationary pressures.)
It does not all boil down to just these four reports. The economy has millions of knobs, levers and buttons being pushed by millions of invisible hands with no conductor. But this week’s jump in rates can very clearly be attributed to the anticipation of a strong jobs report, and then the reality of it. Once the news is digested and analyzed, investors are likely to relax, and once again accept a lower return on their investments.
This coming week has a rare mid-week holiday. On Veterans Day, a federal holiday, most banks are closed and there will be no releases of economic reports. On Monday no major reports are scheduled for release, and on Tuesday no reports are scheduled that are typically market movers. The first significant reports – Jobless claims, producer price index and consumer sentiment – are due on Thursday and Friday.
So, investors have a lot of time to chew on this last week’s unusually strong jobs report and the mitigating factors that will drive what happens in the next few weeks. That usually bodes well for rates, barring more unusually good news.
Finally, let’s put this week in perspective. Look at the chart to the left. You’ll notice the 10-Year bond (red line) is rising rapidly but is still below the highs of the year. It has made several runs at this high this year and has failed to cross it every time. If it does cross this threshold in the next few weeks, we might finally see those higher rates we’ve been expecting for a long time. If it doesn’t, look for it to start working its way back down.
The Fannie Mae 60-day yield (blue line) shows that mortgage-backed securities tend to track the 10-year bond fairly well. (Mortgage-backed securities are the vehicle through which investors invest in pools of mortgages, and so drive the interest rates that you are offered.) Note that it is still well below the highs of the year, however. This tells me that mortgage-backed security investors are not that worried at this point about inflation. Of course, that could change.
Freddie Mac’s survey of locked loans (rates real people actually got this week) jumped up as expected. (green line)
Given the nature of the market reacting to news and then settling down, and given that no significant news is due until Thursday, look for interest rates to improve slightly at the beginning of this coming week. It’s hard to project more than a day or two, but my sense is that we will see slight improvement all week long. We’ll have to revisit this again towards the end of this coming week.
And remember, Don’t Panic! (Yet.)