The Federal Reserve did not raise rates this past week but spooked the market with its future rate forecast. Let's walk through what happened and talk about the weeks ahead.

"You dropped a bomb on me. Baby, you dropped a bomb on me" You Dropped a Bomb on Me by The Gap Band

Higher For Longer

The Federal Reserve met this past week and as expected paused hiking rates once again but, it was their quarterly Summary of Projections that came as a negative surprise to the financial markets and led to a spike in interest rates.

From the last summary three months ago, the Fed sees economic growth coming in stronger, headline inflation higher and the unemployment rate lower. Add it up and it is why the Fed also said they see one more rate hike in December and 2 fewer rate cuts next year.

At the press conference, Fed Chair Powell also surprised the markets by suggesting a "soft landing" is less achievable now and that the Fed wants to see economic growth "below trend" before letting up on rate hikes or an elevated Fed Funds Rate.

All of these negative surprises shocked the bond market. The 10-yr Note spiked to nearly 4.50%, the highest level since 2007. Mortgage bonds, which is where home loan rates are derived, traded down to the price lows of 2022 and 2023 which is an important level to follow in the chart section below.

Going Forward

There are a few sayings that come to mind when looking into the future of the financial markets. One is "Don't fight the Fed". If they say they are going to hike rates again and keep them higher, they will. What could change that? Bad news or a sharp unforeseen downtick in inflation. If future readings on economic growth or the labor market disappoint, the Fed will change its tune...the opposite is true.

The other saying is "The cure for higher rates, is higher rates". As rates go higher, it attracts global investors in search of yield. This helps rates stabilize and improve. We should watch this dynamic with rates at the highest levels in 16 years.

Debt Remains A Problem

A wild card in all of this is our government debt. It just surpassed $33T for the first time and there is no end in sight to our budget deficits. Earlier this year the Treasury surprised the markets with a request for additional funding, which sparked the downgrade of U.S. debt by Fitch Ratings firm. It is not clear if the bond markets have priced in the additional debt, we continue to take on plus the pending debt ceiling debate in Congress, which if unresolved, leads to a government shutdown.

Bottom line: Interest rates are at the highest levels of the year and there is a threat for them to go even higher still. Be sure to watch along with us during these volatile times as the bond market trades at key levels heading into the 4th quarter of 2023.

Looking Ahead

Next week is loaded with high-impact economic reports that could support the Fed's additional rate hike thesis or not. The 2nd Quarter GDP and the Fed's favored gauge of inflation, the Core Personal Consumption Expenditure Index (PCE) will be released. Now, Core PCE is running at 4.2% year-over-year, which is more than double the Fed's target rate of 2.00%. Let's all hope we see moderation in next week's reading.

Mortgage bond prices determine home loan rates. The chart below is a one-year view of the Fannie Mae 30-year 6.0% coupon, where currently closed loans are being packaged.  As prices go higher, rates move lower and vice versa.

On the right side of the chart, you can see how prices are trying to remain above $99. If the Bond can stay above this key level, we could see some stabilization and improvement, the opposite is true.

Chart: Fannie Mae Mortgage Bond (Friday September 22, 2023)

Economic Calendar for the Week of September 25 - 29