Yesterday, Federal Reserve Chairman Jerome Powell spoke with the Wall Street Journal on a variety of topics. What stood out to most financial experts was his stance on inflation in 2021. Though most economic indicators seem to point to inflation this year during the financial recovery from the pandemic, Powell did not express much concern and gave no indication of any upcoming Fed policy changes as a result of anticipated inflation rates. This sparked many drastic reactions in the stocks and bonds market.
The Fed’s Focus on Economic Recovery
Powell and the Fed appear to mostly concerned with employment numbers recovering, which may come with inflation. However, there are no plans from the Federal Reserve at this point to change any policies.
For policy changes to occur, Powell indicated that “We’d want to see inflation sustainably above 2% and we’d want to be on track for inflation to run sustainably above 2%. There’s a lot of ground to cover before we get to that.”
Market Reactions to Inflation Concerns
In response to these comments, bond markets sold off immediately and stocks dropped, with the Dow industrials down more than 600 percent within a few hours. As bonds are sold, Treasury yields are sent higher and this will ultimately have an effect on the mortgage market as interest rates tend to be driven by the yields. In fact, the yields soared higher than they have been at any point during the pandemic. Powell admitted that the yield increase caught his eye, but wasn’t cause for major concern just yet.
Inflation is essentially kryptonite for the bond market for a couple of reasons:
- It erodes the capital of bonds as rising yields struggle to keep up with price pressures.
- Rising inflation means that future interest payments for a bond are worth less.
Bond Market Implications
Powell and other Fed officials seem content to let inflation rise above their 2% target until the jobs market has fully recovered along income, racial and gender lines. Meanwhile, Wall Street investors were hoping to hear that there would be Federal Reserve policy changes as inflation increases. They aren’t necessarily looking for rate hikes, but possibly for the central bank to adjust its monthly asset purchases. One example might be selling short-term bills and buying longer-dated notes to help raise yields in the short term while lowering them over time to flatten the yield curve.
Another concern is that interest rates may go up rapidly in response to inflation. We’ve been enjoying historically low rates in the mortgage market this past year. We’re expecting them to keep shifting upward, but inflation could have a dramatic impact and really cause a major rate hike.
Impact on Mortgage Rates
It remains to be seen how much inflation we will actually see as the economy continues to recover, and then how that inflation will affect the bond market, the stock market, Treasury yields and mortgage rates. From a mortgage perspective, all signs appear to be pointing toward higher interest rates ahead, which is why it is good to lock in a good rate while you can. If you have been putting off a mortgage refinance or are looking to buy a home this year, now may be the best time to act.
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