The FOMC’s median estimate of the natural real interest rate remains pinned at 0.5%, allowing Fed Chair Powell to claim that policy is “well into restrictive territory”. But this is simply not credible. Even a higher estimate of 1.19%, based on the one-sided Laubach-Williams model, is likely to be too low, with a federal budget deficit of 7.5% of GDP in FY23.
The 10-year TIPS yield dipped to 2.00% on Friday, but underlying economic growth appears to be firming. On an unadjusted basis, initial claims dropped to 198.8k in the w/e November 25th, below the level of the comparable week in the year prior (199.3k). The average 30-year fixed mortgage rate has fallen from a peak of 8.09% on October 26th, to 7.48% on Friday. The S&P homebuilders index has subsequently rebounded 22.0%. The Chief Economist of Redfin has warned of “bidding wars” next year if rates fall below 7%, which is highly likely. House prices had already jumped by an annualised 9.8% in the six months to October according to Freddie Mac.
The surge in cryptocurrencies suggests the policy rate may not be far off from becoming too loose once again. Even if the Fed cuts rates as expected, the 10-year Treasury yield could resume its uptrend in 2024, back up to 5%. Term premia (10-years) should be 50-100bps higher than they currently are. The prospect of a second Trump Presidency will increase the term premium too.
In addition: the Baltic Dry index has now jumped to the highest since May 23rd last year, due to the drought in the Panama Canal and stronger demand for iron ore. It is an important reminder: large government deficits, combined with El Niño, and climate change, could combine in unforeseeable ways next year. 2023 was a year for shattering climate records, but 2024 could be even hotter. A paper published in Science last month, found that a doubling of a given CO2 concentration is not constant: greenhouse gases becomes increasingly more potent, the more carbon dioxide is released into the atmosphere.
