The Fed Lag and Mortgage Rate Dilemma

Published Feb 24, 2023, 3:15 PM

Bloomberg Chief Rates correspondent Garfield Reynolds says the strong start to 2023 might just be a red herring. He joins to break down rate moves and explains what recent eco-data and hawkish Fed messaging might mean for the US economy. Opinion's Tim Culpan discusses the exploding interest in ChatGPT and outlines the risks of artificial intelligence developed in China. Columnist Alexis Leondis also joins to discuss the mortgage double-edged sword.

Welcome to Bloomberg Opinion. I'm valny Quinn. This week film new homeowners are feeling stuck. You know, they're lucky enough to have a low rate, but they're afraid to move where They're just worried that the costs are going to be so exhorbiting compared to where they are right now. A conversation with Alexis Leander's on homeowners feeling trapped by they're cheap mortgages. And if you're going to use the Chinese burdon or chet GPT, it's going to align with the Communist Party's view of the world. Right, So if you ask them politically sensitive questions about us or Taiwan or China's place at the world, you don't get that view of the walk. Tim Colvin on how chat GPT will perform partially according to its ideological underpinnings. First, though, to this extraordinary month in markets, particularly rates markets, chief rates correspondent to Garfield Reynolds joins Garfield, You'll start the month at four point one o nine. On the twos, we're now at four sixty nine, and on the tens we were at three forty two and now above three eighty seven. To some extent, that's just a regular repricing, right, the Fed moving by twenty five basis points and signaling more to come. Looking back on the month, has it been an easy repricing or did it cause pain in places? No, it's definitely not been an easy repricing. The market had to abandon the thesis that the Fed was close to calling halt and that then we could start anticipating when they're y cut. We had seventy five basis point hike in November, fifty in December, and then as expected at the beginning of this month, we had twenty five. So the market was sort of going, okay, next move is no interest rate hike at all, and the next move after that as a cut instigate. The FED has made it clear that it's going to do multiple hikes from here. In fact, by now the pricing is for three more at least, and that it's going to hold rates higher for quite some time. Now. That's a message the FED had been tending for some time. It took several punches to the gut for bond bulls before that message got across. Is the message now across? Yeah, I mean the message is now pretty much across you can partly see that, you know, there's a lessoning in volatility and a willingness for some investors to come back in at these elevated yields, a sort of buy and hold investors. But there's kind of a sense that the bond market at the very least is no longer fighting the FED. It's now much more closely in line with the FED. Starting with that rate prices that we talked about, where the expectation is for a pig rate of seventy five basis points high per year and probably no rate cuts until next year. Ten year yields seem to be reluctant to cross that four percent level again that they did last October November, but not since. The question might be if three point nine seventy four, which was the high most recently, does that represent the bearish extreme intends for the time being. Do you think no? I don't think it does. I think that's a level that has been attractive to buy and hold investors that had a lot of people talking to me about dipping their toes in at this sort of level. But that's the thing. They want to be sure the temperature is right there, So things like PC price indicator, next month's jobs data, well this month's job data report at the beginning of next month. Then also inflation and what the fat says that it's brass meeting. All of these things have the potential to provide fresh either data or central bank stance shocks that could readily drive you higher. There is a pretty strong anticipation that it does go higher, you know something. Four point three percent is still seen for the moment at least being probably the peak of this cycle. I'm a bit skeptical about that estimation, considering that historically ten year yields have topped out around about the same level as the fence cash rate, and the fence cash rate is already considerably above that four point three three percent pick we saw an October for the ten year yield, so potentially more pain to come. Who's feeding that pain our field? Bond investors are certainly feeling that pain. The global aggregate impact. It had its best January ever and those gains almost got wiped out in February, So bond investors are certainly suffering. At the very least, they're looking at the potential that this year, if it is going to be gains is going to be gains eked out rather than a strong bounce back which they were looking for. There's also been pain spreading across the equities as they have lost momentum. And again they initially they were holding up okay when done to turn south, and there was some thought that the strong correlation we had seen between the two usually not correlated asset classes was going to break instead that swinging back, and that's likely a bitter case until the tightening cycle is definitively over. Yeah, I mean, it's really interesting because we didn't really see the reaction in say, the mega tech companies that we might have expected in quote unquote more normal times. That has yet to come, I guess too potentially. Yeah, well, I mean, and that depends a lot on how the economy develops. If you look at consumer sentiment drawing higher, the City Group Economics Prize Index shows that most data releases are beating expectations. So and yeah, the Atlanta our Fair tractor is a decent level and it comes to GDP, So the economy is showing a fair bit of resilience. As long as the economy shows resilience, you can hold out hope that equities in particular, look get through this with decent games, or even better than decent games, especially when you're thinking of text. Worry has to be that there's still a strong expectation for a recession, so at some stage of recessions gain't hit. That's still the base case for most investors. And the question is, you can meg Tex and other companies hold on to the gains that they've booked so far this year if we do get a recession, especially if it's a deep one and not a shallow recession. But if the labor market tightness doesn't weaken a little bit, how can we possibly get a recession? Well, and to some extent that's defends reasoning and willing to go higher and higher on rates to make sure inflation comes down. You know, they regularly refer to the lessons of the nineteen eighties where they eased off too soon is the received wisdom, And they ease off too soon why because it look like the economy was going into recession. But why should say ease off now unless inflation is visibly on its way down sustainably to the target range, if the labor market is still this strong, if the signs of recession aren't there. They kind of said, look, we're not going to stop until inflation is down, even if we're risking a recession, and at the moment it doesn't look like the risking a recession, so why stop. We did get the minutes this week too, though, Garfield, and it seemed like because we didn't know as much then as we know now, FED officials were also willing to believe that things were going in their direction, when in fact, then we got this massive jobs reward and plenty of economic data that suggested inflation wasn't coming down. Our FED officials willing to believe that the lag is actually shorter than it is. Too well, I think FED officials are very much you watch and respond mode. Part of the point of the steep rate hikes from last year was precisely to get from extremely loose conditions where they were helping to exacerbate an overheated economy to restrict fift territory. Now, from the first point of view, now that they're in restrictive territory, they can take smaller steps as they increase that level of restrictiveness, or even pause for a while to see if that level is as restrictive as they need to get. But that's very different from a scenario where they say, oh, okay, we've done enough, therefore we can look to cut rate again. They're only going to look to cut rate if a inflation is back down very close to target and they can see that the economy is really really in trouble. Now in the short term of they're more alert for our signs that the economy is continuing to show more strength, and they expected then the Minute seemed to indicate fifty basis points might be back on the table, and certainly at least three twenty five basis point heights seems to be a consensus for what is the base case of what's going to be needed. And if the data continues to come in stronger than next fact that well then they would look to If they don't go fifty, then they might go further, just with their twenty five places point hikes to keep the pressure on Garfield. Since the market is still projecting a chance of a rate cause in December, does that imply to the market things there will be a month where we suddenly see the data completely fall off a cliff, because there's not that many months left between now and December. Really well, yeah, they do obviously see a fairly swift turnaround, and to be fair, previous cycles we have seen that sort of thing. We've seen a switch to ray cuts or at least to an easy bias within three to six months of the peak in the fad rate. Now, as people are in pointing out to me, the difference is this time around in casement is much more elevated. So that's going to stay the fair hands to some extent, you would think, unless the data really collapses when it comes to turning towards ray cuts. But there are a lot of difficulties in navigating the current climate because so much in the way of data and other phenomena are extraordinary in the because of the pandemic and the post pandemic, you never quite clear to what extent things can revert back to how they were in the years before the pandemic. But you know, markets and the climates inevitably do factor in historical modeling. So if you think that things are going to work the way that they worked in the past, and if you look the latest Bloomberg Economist Consensus recession indicator with it a sixty five percent chance of a US recession within a year. If you think there's a better than fifty percent chance of recession within a year, you probably think there's a better than fifty percent chance of racer within a year. Stay tuned. We continue our conversation with Garfield Rentals and moments on Bloomberg Opinion. You're listening to Bloomberg Opinion and Vannie Quinn. Let's return now to our conversation with Garfield Renals. We'll get as thoughts on the churn at the Bank of Japan and moment. But first, this process is likely to take quite a bit of time. It's not going to be we don't think smooth. It's probably going to be bumpy. And so we think that we're going to need to do further rate increases, as we said, and we think that will need to hold policy at a restrictive level for a period of time. Some final thoughts on FED chair Powells dilemma. How does FED chairs your own Powell reconcile saying we are going to get to a certain point and we are going to hold I'd also say your data dependent and you might need to move basically with a trigger finger. Well, the loadstone for the fad remains inflation, and as long as that is at the elevated level, that is you're well about the faith target. They can be clear that we are more insted in racing rates from here than in holding them alone lowering them. If it does come down strongly from here, you know, if we do get a return to the disinflationry trend that we've had, anything, that placement trend accelerates. Some way of saying, if we get inflation coming down faster than than it currently is and two levels that would be consistent, well, then the FEND could be willing to switch to an easiest to a less hawkish bias, especially if there are also signs that the economy is starting to roll over. However, if you've got inflation coming down rapidly so you can see it getting to the appropriate levels, but the economy is still burning, well, you're sort of not going to be interested in cutting rate because that would be repeating the mistakes of the verteen eighties, which is what they said they don't want to do. And you know, the feed is said the path they do think they can achieve a soft landing, but it's a very narrow path. That also signal that they're willing on the side of risking a hard landing, provided that ensure that inflation is tained this time round. They don't want to see elevrated inflation lasting for a long time and fitting into expectations. So that's part of why bond space the potential for further pain, because if the Fed is willing to stay harsher for longer, that that could keep yields higher for longer. And also why equities could face a bit of a double jeopardy, hey, because race might be higher than they think me because the feed might end up with that hard landing despite the best effort, and that's not going to be good for stops. It might be good for bonds, it's probably not going to be good for stops. Garfield Green pivoted Japan for a moment. How in control is the BOJ It appeared that traders were attacking the point five percent upper limits on the band again this week. Oh, they certainly were, and they're difficulty years. There just aren't many ten weird bonds around in Japan because the BJ's bought the more so it's not easy. The benchmark yield has closed at the two point five percent target every trading day since Jevary ten when it rose to that level, and then it's been stuck there, even if the last couple of days it's jumped above. Now, overwhelming consensus is that yield curve control is going to have to go, probably sooner rather than later. That it's not sustainable that who later will have to change things once he becomes BJA governor because the BOJA owns too much of the market already, it's dysfunctional. It causes your problems for banks, for other companies with everything that's going on, and also the concern that the end could resume steep declines unless the finds a way to buy fuel bonds. So those are all the issues and the difficulties. There's is very strong inticipation that Japanese year's going to go higher, don't. I question is when, and the secondary one is how, because there is a way. Yes. The reason worry that if you take the lid off again or even you know, shifted a little bit higher, that all sorts of volatility could could break out, and in particular that you could get foreigners fleeing the short end of the market where they've been looping the rewards of the cross currency basis trade, and that that could send yields jumping on a range of tenors. That that could then set off an evaluation shock for Japanese investors. You'll hold those bonds now suddenly have to market to market. So there's a lot of your concerned bubbling away beneath the surface. Even as a stretch of metaphor, the Bank of Japan pushes down hard on the lid of the borrowing clothing that it claims to control. Right, I mean, it's a terrifying prospect for casual way. The end national core CPI is at four point three percent, so it's not as if it's helping really in terms of inflation or what the longer run outlook for inflation will be. Obviously Japan wants it back up to two is casual way they're suddenly going to innovate in monetary policy and think of something new. Well, that would be one way to result. The difficulty is, you know, what can they come up with and how do they try and move back to a more normal way of doing things when they own so much of the bond market and may also have a government that season needs to spend, for example, on defense and on other reforms, and so it's going to go on borrowing. It's not going to want to see Japanese yields go too high. Japan in general is it a country where they prefer to see things moved at a measured pace most of the time. So you think he's going to try to be contatory, he's going to try to move gradually, But then he himself has said at times that if you're going to end yield, curve control and negative rates, that be better to do it in one fell swoop in order to avoid everybody betting against you, and in order to be able to control the process better than if you signal or allow people to assume that it's going to be something that takes place gradual. Right now, options markets are positioning for him to retain flexibility. What are the odds and have realized I'm asking you to answer something that's really unanswerable. When do you think there's any possibility that he might actually do away with it completely in April and to surprise everybody, that's a possibility is soon to be predecessor. Corona managed to surprise markets ten years ago when he took over, and everybody knew that some sort of extraordinary monetary easing was coming, because that was part of the three arrows. But the way he did, at the extent to which he did it course huge shots. Initially, and in fact, on the first week or two of a Japanese yields jump up and then down, there was a lot of strains, There was a lot of concern, a lot of volatively and again as well and then in twenty fourteen, So for a seconds to Rota also surprise again. Even though people were expecting him to increase easing, they weren't quite sure that he shocked them with the way he did it. So there's definitely an extential for a surprise that would be very surprising to think. The more likely scenario would seem that he tries to hold the fort for a while at least while he commissioned a review or takes measures to try and improve the way the market is working. Whatever he does, in a lot of ways, he is going to surprise, because if he does do essentially nothing at the first meeting, that's also going to be a shock, and a lot is going to depend on how well he sells whatever the message is that he's sending. This is his first chance to show what he has when it comes to being a communicator of policies or potential policies and how he sees things being developing. And in particular he's also obviously talking to a very important constituency, the Japanese governing PLATH Chief Rates correspondent Garfield Reynolds. There next is your chat GPT Benign well define Benign will speak with Bloomberg's Tim Colbyn and Taipei. This is Bloomberg Opinion. You're listening to Boomberg Opinion. I'm Vannie Quinn. China may have a chat bought advantage, according to Bloomberg Compinions. Tim Kulpin, we had an IRL conversation about the ethical questions surrounding this technology that's seeing a race for territory from many of the major tech companies across the globe. Generative AI has obviously suddenly become the revelation Dure. You've pointed out that domestic internet companies in China had an advantage in search because literally the Great Firewall or the companies weren't even there in the first place, or they left once censorship threatened their product. So now China has potentially a chance again to seize the territory, explained to was your thesis. So one of the biggest struggles we're seen with chat GBT, and that's essentially a brand name of open ai to start up. One of the challenges that's seen already is that it doesn't always get dry. And then when Google came out famously just recently and showed off their own version literally in their initial ads, they made a mistake, right, So the problem is that they're gathering from a huge corpus of information while this information is conflicting, right, so you know, it mixes up east and west, north south, you know, black and white, this is sky blue, right, that kind of stuff, and like, you know, a humanise that doesn't make sense. But because it is just about it's not smart. We see a lot of stuff spat out bra chat GPT that looks very confident, it looks very authoritative, but then uncloser inspection, you realize it's rubbish. It's just not true. And that's because they are working on a very large corpus of information out there in the world, including social media things like Reddit, and you know, there's not necessarily any fact checking going on in social media. Shock corra, and so that's the problem, whereas in China it's a bit dystope into savors. In China, if you're crawling the corpus of Chinese information because of censorship, then the information you're going to see on the Chinese Internet is I wouldn't say it's it's true or accurate, but you could say it's veted to an step. Now, not all information in China has been sensed. That we have so many years of this structure of censorship and control of information that if something is online in China, on a website on social media, even if it's not necessarily true in the factual sense of at least some sense or whatever has better and said yes, it's true in our eyes. And so that means that the chat GPT versions that are being developed by companies like bay Do natis in Auli Baba, if they assume that they call only the Chinese website, then they're going to be calling vetted information. And so the information may spit out when given a query is going to be somewhat more aligned with what sense it might call accurate, and so you're going to get information that does align to be somewhat generally correct, is it You're not going to have these problems. Is it possible though, that these versions will have their own biases built in because of the nature of China censorship? Oh? Absolutely so, if you're going to use the Chinese version or a chat GPT, it's going to align with the Communist Party's view of the world. Right, So if you ask them orthically sensitive questions about US or Taiwan or China's police of the world, you aren't don't get that view of the world, right. That's absolutely going to happen, Not because the chat GPT boss itself is necessarily biased, but it's coming from a biased view of the world. You know, the corpus that is dragged, you know, it's pulling its data problem is going to be aligned with that. So that's definitely going to be a problem. But in the initial phases of training, this stuff around very very very early days of all that is happening. This is a ten twenty year thing, and the very early days of it. The biggest risk you have with any of these chat bots is either keeps spinning out bad information people won't rely on and they won't trust it. They may move away from it, and the other thing is you can manipulate it. Right. It wouldn't take much for me to set up a chat GPT bot, find a topic that I want to basically rewrite the narrative on balloons in the Sky and UFOs for example, and I could just use chat GPT to create, for example, to create a lot of false fake news and then post that on various websites. Act to create a website, I could put it on Reddit, and then this corpus. As these corpuses of data they train on get updated, it would be taking in the fake news that I've created, So it would be this echo chamber of problematic false news. And you can do that in the West because we have basically free speak. In China, much more difficult to do that. So the misinformation in China would be state responsored misinformation, which you can control and you can put it in what a direction life. But when it's in a Western countries or those more free and open information my theories, the parents actors could come in and use these tools, manipulate them and poison the data, poison the well of information they're using to train. So by do as announced, it's going to debut about next month, Ali Baba is already conducting internal tests on a chat tool, and Neetti's is also unveiling plans to offer something that's slightly different sphere there that's an education. Given that Internet seems so much more regulated in China, do you imagine that users will come from around the world to use the Chinese ones and vice versa, that perhaps Chinese companies or Chinese individuals even we'll want to use US ones or will this be something that will be very tailored to specific markets in terms of territory. Yeah, I think I think that's a key point. I think we're back to where we were in fifty years ago with search engines, where you know, Baidu has had the market to search in China for a very long time because the Western companies like Google and who really couldn't get access to the market. So we'll be back to that point. What we will see is ACCURSS is a huge issue. We don't have data from open Ai now about how accurate they are that released in the data. I think at some point they will have to. But at some point in future, when bay Do, Ali, Baba, Microsoft, Google, all these companies start coming out with various metrics about how good their chat bots are. That'll be saying we're going an accuracy rate of this, or maybe third party researchers academics will do research and come out with accuracy numbers. We will actually see the Chinese versions have that accuracy rate because they're pulling from a smaller corpus of data. But in the longer term it won't matter because you know, China is not going to allow Microsoft and Google and all the other overseas chat bots to service the Chinese market. That's not going to happen. And now with the way things are training with TikTok for example, and struggling even stand in the US, I don't imagine that by the chat bots Ai or Ali Baba's chatbot AI is going to be allowed to access the American market. So we're going to have a very distinct kind of market for the two, and that will allow both of them to claim that they're better the other better one maaticus. It will never be a head to hit that chap. Is there something that usmpanies can learn though from China companies? You say that content self regulation is built into the DNA of Chinese internet companies, and obviously that's something that resonates because content self regulation. I suppose there's another word for potentially another phrase for a censorship, but the fact that China is doing it and has been doing it for a long time and has managed to sort of police this crazy wild West. Is there something that a Facebook and a Google and all of the others can learn well, it would be a dangerous thing for foreign website social media companies and put forth to go down that road. I don't think it's worked out for the chat people, and I think in the long term, I don't think it's sustainable these arguments to be made about you know, why China needs could do this to keep social stability and so forth. I really think in the long term it's a net negative. I think the real struggle that the companies in the West, not just the US, in the Western general I kind of face with these kind of AI chat box and so forth, is ensuring that the data they're using informant and train on is clean, is correct as correct information. I think that problem can be solved over time. I don't think they're going to be able to rely on content moderators, But if you've waited more heavily to authoritative sources such as say, US outlets or government information. So if you want to write about stars and telescopes and supernova you probably would wait that more to say the European or the North American space agents. You rather some blog or some Facebook post. Right, academic journals might be a place you might want to more heavily wait over something you see on Twitter. So there's ways that you can wait these things to more authoritative things of variative sources. And you know you might, for example, have news media up higher compared to social media now of course, or people disagree with that, say mature media can't be trusted, but there is ways that you can keeper with it to ensure that you're wasting it more heavily towards known author its sources. Over time, the AIS can learn from that, so it is it's not a helpless problem. It can deal with. It's just a matter of ensuring that these companies slow down, don't rush to get things out, slow down and really think very very carefully about the sources of their data and not being not hard to put every bit of data available into the training algorithms so that they can have better returns. To be the output, Bloomberg Opinions, Tim Colvin, Bloomberg Opinions. Alexis Leanders joins now to discuss a problem with the housing market that started as a gift. So, alexis, what do the data show us about homeowners with mortgages who already have a rate below four percent? What kind of situation are they in right now? We see that about two thirds of homeowners right now who have mortgages are sitting pretty if you well, with a rate below four percent, So that means, you know, they purchase homes or they refinance that they have pretty low rates, and many of them are feeling stuck. There's this lock in effect where if they were to buy a new home, they would lose that rate, and sometimes if they have a three percent rate be looking at a six plus percent rate. So because of that, so many homeowners are feeling stuck. You know, they're lucky enough to have a low rate, but they're afraid to move, or they're just worried that the costs are going to be so exhorbiting compared to where they are right now. What if you don't want to move, what can you do? You feel like your current home is too small or too old or has things about it that you want to change. You know, then maybe it's worth taking out a second mortgage to renovate, and then you can stay put. You don't have to give up your old mortgage rate. You take on a new mortgage rate that, yes, is going to be more expensive, but combined, when you have this blended rate, you actually may be paying less than you would be if you went out and bought a new home or try to do a cash out refly on your assisting home. So how does a second mortgage work in that case? Then? Do you just get the prevailing mortgage rate for a certain amount of money, But obviously it wouldn't be as much of an amount of money as if you're actually buying home. That's exactly right. So basically what you do is you tap the equity in your home and you take out a lump sum at a fixed rate, typically for years, while keeping the original mortgage intact. So because of that, second mortgages tend to be for smaller amounts, and they're also known as home equity loans, but they're different from home equity lines of credit. There the rates are variable, as is the amount you're extended. A line of credit, so you know, you may borrow more or less, but with the home equity loan or the second mortgage, you're basically taking out a fixed thumb. Do you cassion on the amount that your home is appreciated by and try and buy something maybe just a little better or not, because if you buy something a little better, you're going to be as you say, siman buy that new mortgage rate, right. And that's why. Also I want to point this out, is home equity is still at records. Yes we've seen home prices dip a bit, but they're still up forty percent. So because of that, people are sitting on an extreme amount of wealth in their actual homes. So that's part of this idea of well how can I leverage my home? Don't want to overleverage, We don't want to go back to the dangerous space leading up to the Great Recession. But what can people do safely to kind of tap the equity in their home and be able to renovate or use the proceeds to pay down debt or do smart things with that money, Because again, they're sitting on their homes that are worth quite a lot. And that's why. So if you were to do a cash out refi. There's a very helpful example from Laurie Goodman over at the Urban Institute's Housing Finance Policy Center. Let's say you want to take out one hundred thousand dollars in home equity. If you were to do a cash out refi, you would say, pay around a six and a half percent new interest rate on a loan. You would have a monthly payment of about nineteen hundred dollars. But if you keep your existing mortgage rate, let's say three percent, you take out a second mortgage at a much higher rate. Even when you blend that together, your total monthly payment for both loans is probably going to be less than it would be if you did the cash out refi. Now, alexis not all banks, Not even many of the traditional banks do second mortgages, do they? Right? Some do. I think you'll have a better chance if you aren't interested in doing a second mortgage looking at some of the non traditional lenders. Rocket Mortgage offers a product Pennymack does as well. They've all introduced versions relatively recently, and again, just keep in mind that you will have to have good credit in order to qualify for these things. Probably not quite as high a credit score as you need to have with the home equity line of credit, but you'll still have to have a good credit score, documentation of income to show that you have the ability to repay, and so forth. So I do think we're going to see more interest in these products than we have in the last few years. And do we have any date on how many people are tapping into them yet or whether that number is rising. Yes. According to Equifax, from January to August of twenty twenty two, second mortgage origination totaled more than fifty billion. It was about fifty three billion. Now, remember it's a very very tiny sliver of the overall, you know, tillion dollars mortgage market plus, but that fifty three billion is a fifty percent jump from the previous year. So there is more interest, that's for sure. Bloomberg Opinions Alexis Leander's there. Well, that does it for this week's opinion. Do feel free to get in touch. I'm at Vannie Quinn on Twitter or email me at v Quinn at Bloomberg dot net. We're produced by Eric Mallow. Stay with us. Today's top stories and global business headlines are coming up right now,

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