Mortgage bond prices finished the week slightly lower which pushed rates a bit higher. Trading started on a sharply negative note as traders positioned themselves ahead of the expected Fed rate hike. We recovered some of the losses later in the week amid mixed economic data. Consumer prices were unchanged in Nov. and the core value, which excludes the volatile food and energy costs, rose 0.2%. That data was near expectations and supports the Fed's 2% inflation target. Housing starts printed at 1,123K versus the expected 1,150K. Weekly jobless claims were lower than expected at 271K. The Philadelphia Fed survey, an indication of manufacturing strength in the Mid-Atlantic region, fell 5.9%. Traders expected a 2% increase. Leading economic indicators rose 0.4% which was stronger than the expected increase of 0.1%. Mortgage interest rates finished the week worse by approximately 1/4 of a discount point. Fed Rate Hike The Federal Reserve hiked rates this week which ended a seven year period of a near zero interest rate policy. The Fed began easing monetary policy in August 2007 to support the economy at the onset of the Great Recession. Over the next 16 months rates were cut an additional 11 times as economic conditions continued to deteriorate. Global financial markets were in turmoil, stocks lost half their value, and the banking system seized. The Federal Reserve along with other central banks coordinated an attack to stop the carnage. After seven years of ultra-accommodative policy the Fed hiked rates to ward off potential inflation. The Federal Reserve has two mandates from Congress, full employment and price stability. Jobs: The unemployment rate is 5% and hiring has been strong in many regions. By many measures the mandate is fulfilled. The Fed would like to see wages rise. The middle class has not seen wages rise above inflation since the 90's. With 67% of the economy driven by consumer spending, a pay raise to the middle class would be beneficial to the overall economy as long is inflation does not get loose. Price stability is another issue. Inflation has been stubbornly low. Europe is battling deflation. While it sounds like falling prices would be a bonus for consumers, it actually can cause them to delay purchasing goods and services opting to wait and see if they can get a better deal later. This causes an economy to contract (lower GDP) and can create a "death spiral" for economic output. One irony the Fed faces is the US dollar. Global commodities are priced in dollars. When the Fed started talking about raising rates at the beginning of the year the dollar surged in value and commodities got cheaper, creating a downward push on inflation. In addition, a strong dollar makes imports cheaper further pressuring inflation to the downside. Other considerations the Fed is facing include China, Europe, emerging markets and the potential for another global recession. China's economic output (Gross Domestic Product) is falling which is causing pain in many emerging markets. China's appetite for raw materials such as copper, coal, steel and cement to name a few has supported many other countries that export to them. Many emerging markets such a Brazil have borrowed heavily in US dollar dominated debt because it was cheaper. As the US dollar becomes stronger versus the home currency the cost of the loan rises in the home country. Rising borrowing costs and lower economic output because China is slowing has the potential to cause another market route. Global traders are not as concerned over the first rate hike. It is what happens next that causes them heartburn. Low interest rates have helped many companies and consumers in the past 7 years. However, at some point the Fed had to take away the punch bowl or risk creating another bubble that could pop and result in extreme financial crisis.
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