Economics Nerd Central/ The Global Inflation Thread

[CaptainSensible]

Fed increased interest rates to 3-3.25% yesterday, Bank of England have just jacked rates up to 2.25%.

There's likely more to go based on the reports of the voting and Fed expected to hit 4.4% by end of year according to consensus.

Expect at least another couple of percent on the ECB interest rate over the next 6 months.

Once again, if you haven't fixed your mortgage rates, do it now.

That's not how it works.

The 10 yr bond rate is based off the expected average rates over 10 years (these expectations are priced into the 10 year rate, so if the BOE is expected to raise rates by 50 bps in two months time and they subsequently do and after they comment that the market is in tune with their thinking, than the 10 yr rate would hardly budge) therefore while the BOE rate is 2.25 now it also comprises of an expected rate of say 2.75 by Nov and 3.25 by Jan and possibly 1.75 in 6years time etc.

So the real question you ask is do you think all these rate rises will lead to a deep recession in which case short term rates may come down quicker than expected (don't fix) or conversely if you think it won't lead to a recession or only a mild one in which case rates will stay higher for longer (which would imply fix now). Similarly another question is how long do you think inflation will remain high.

 

[Happyhonkaman]

Fed increased interest rates to 3-3.25% yesterday, Bank of England have just jacked rates up to 2.25%.

There's likely more to go based on the reports of the voting and Fed expected to hit 4.4% by end of year according to consensus.

Expect at least another couple of percent on the ECB interest rate over the next 6 months.

Once again, if you haven't fixed your mortgage rates, do it now.

I fixed mine at 2% for 4 years today

 

[How bad boy]

That's not how it works.

The 10 yr bond rate is based off the expected average rates over 10 years (these expectations are priced into the 10 year rate, so if the BOE is expected to raise rates by 50 bps in two months time and they subsequently do and after they comment that the market is in tune with their thinking, than the 10 yr rate would hardly budge) therefore while the BOE rate is 2.25 now it also comprises of an expected rate of say 2.75 by Nov and 3.25 by Jan and possibly 1.75 in 6years time etc.

So the real question you ask is do you think all these rate rises will lead to a deep recession in which case short term rates may come down quicker than expected (don't fix) or conversely if you think it won't lead to a recession or only a mild one in which case rates will stay higher for longer (which would imply fix now). Similarly another question is how long do you think inflation will remain high.

Yes, well aware that the interest rate announcement is much more complex than the headline, so is almost everything else in macro...
But mortgage interest rates tend to track that headline target rate...

It's MV=PY, right? My thesis is that V has recovered, revealing the increase in M during Covid.

Tidying that up means you can still have inflation and a recession, because its hard to control which of P or V you reduce when you reduce M.
And of course, there's the drop in the pound + balance of payments disaster thanks to Brexit also dragging down GDP...

Combined, can make it very difficult to drop interest rates in the recession.

 

[CaptainSensible]

Yes, well aware that the interest rate announcement is much more complex than the headline, so is almost everything else in macro...
But mortgage interest rates tend to track that headline target rate...

It's MV=PY, right? My thesis is that V has recovered, revealing the increase in M during Covid.

Tidying that up means you can still have inflation and a recession, because its hard to control which of P or V you reduce when you reduce M.
And of course, there's the drop in the pound + balance of payments disaster thanks to Brexit also dragging down GDP...

Combined, can make it very difficult to drop interest rates in the recession.

The point I'm making is, if you walk into a bank tomorrow to get a mortgage, there will be no immediate benefit by choosing a fixed versus floating rate, as both will be priced to yield the same profit to the bank based on future interest rate expectations. Basically you are being quoted the same rate from their point of view.

It is only if these expectations are proven wrong (which is always the case) that you will either benefit or not based on whatever option you choose.

So it is incorrect to tell people they should switch to a fixed rate unless you think interest rates will exceed expectations and stay there for longer.

 

[How bad boy]

The point I'm making is, if you walk into a bank tomorrow to get a mortgage, there will be no immediate benefit by choosing a fixed versus floating rate, as both will be priced to yield the same profit to the bank based on future interest rate expectations. Basically you are being quoted the same rate from their point of view.

It is only if these expectations are proven wrong (which is always the case) that you will either benefit or not based on whatever option you choose.

So it is incorrect to tell people they should switch to a fixed rate unless you think interest rates will exceed expectations and stay there for longer.

That's a little too Efficient Market Hypothesis for my liking, i also think interest rates are very heavily priced based on market pricing, far more than future expectations, primarily due to market competition.

You only need one or two competitors in the market who are more bearish on the market to drag the charged rates down, and a mortgage sales manager who can't offer market competitive rates isn't going to be selling many mortgages. I wrapped up my remortgage for 5 years at 1.59% slightly before the start of this thread.

IMO, it was a pretty risky bet on behalf of my mortgage provider, unless they can offload the risk (almost dead certainty) of losing substantial amounts of money on that deal in real terms over the next 5 years.

I honestly haven't been paying attention to what's happening on CDOs, but i presume that's how banks are planning on not going bust (again).

"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing"
Citigroup CEO Chuck Prince, 2007

I don't think mortgage interest rates are as forward looking as you claim

 

[CaptainSensible]

That's a little too Efficient Market Hypothesis for my liking, i also think interest rates are very heavily priced based on market pricing, far more than future expectations, primarily due to market competition.

You only need one or two competitors in the market who are more bearish on the market to drag the charged rates down, and a mortgage sales manager who can't offer market competitive rates isn't going to be selling many mortgages. I wrapped up my remortgage for 5 years at 1.59% slightly before the start of this thread.

IMO, it was a pretty risky bet on behalf of my mortgage provider, unless they can offload the risk (almost dead certainty) of losing substantial amounts of money on that deal in real terms over the next 5 years.

I honestly haven't been paying attention to what's happening on CDOs, but i presume that's how banks are planning on not going bust (again).

"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing"
Citigroup CEO Chuck Prince, 2007

I don't think mortgage interest rates are as forward looking as you claim

A 10 year mortgage rate is priced using the 10 yr interest rate swap (fixed v floating).

This 10 year interest swap curve is calculated using Libor rates going out 10 years, which is totally based on future expectations.

Therefore at day 1 there will be no difference in which mortgage you choose, as no one can tell the future you will either benefit or not depending on how accurate these interest rate expectations prove to be.

Generally banks will sell government bonds they are holding to hedge against giving you a fixed rate. i.e they sell a bond in which they receive a fixed coupon from the government in return for receiving a fixed payment from you, but at a higher rate than the government bond albeit with more credit risk involved, or they will take the other side using interest rate swaps, i.e they pay fixed (10 yr rate) but receive floating (3 mth libor) to another bank which is offset by receiving fixed from you combined with paying floating on a daily basis ( borrowing short term) to finance the mortgage they gave to you. Really the only way they should lose on mortgages is if you default or they are not properly hedged.

Competition as you mention will only eat into whatever extra margin they charge customers as opposed to the market rates they deal with other banks.

 

[How bad boy]

Looking like the Bank of England is going to hike rates again, but really up to only 1%:

Fourth rate rise in a row looms at Bank of England as job market remains red hot

City economists think the Monetary Policy Committee will hike the UK’s interest rate to 1% at its next meeting on May 5

www.standard.co.uk

I really think the ECB are going to have to hike rates ahead of when they thought.

Here's the minutes from their policy discussions for last month:

Monetary policy decisions

The European Central Bank (ECB) is the central bank of the 19 European Union countries which have adopted the euro. Our main task is to maintain price stability in the euro area and so preserve the purchasing power of the single currency.

www.ecb.europa.eu

Their reasoning for keeping rates low was:
"Any adjustments to the key ECB interest rates will take place some time after the end of the Governing Council’s net purchases under the APP and will be gradual. The path for the key ECB interest rates will continue to be determined by the Governing Council’s forward guidance and by its strategic commitment to stabilise inflation at 2% over the medium term. Accordingly, the Governing Council expects the key ECB interest rates to remain at their present levels until it sees inflation reaching 2% well ahead of the end of its projection horizon and durably for the rest of the projection horizon, and it judges that realised progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilising at 2% over the medium term."

Think with inflation in the Eurozone at 7.5%, it's hard not to reason that there's a significant risk of overshooting that target of 2%...
They're meeting tomorrow, I'd be surprised if they don't announce a rate increase.

Looking at the Irish bank rates, they've already priced in the increase.


There were banks in the UK offering below 1% fixed rate mortgages. Some of the rates on offer last summer were nuts, Natest were offering a 5 year fixed rate mortgage for 1.17%. The BoE rate will almost certainly be 1% next month.

I really don't see how this can't result in a reduction in house prices in the UK.
As for Ireland, let's see what comes out of the ECB tomorrow, but again, if you can't borrow shittons of money for cheap, then you can't pay extortionate prices for houses...

Bank of England raising rates to 4% today, UK house prices down for a 5th month in a row:

House prices fall for fifth month in a row

The price of the average property in January was £258,297, a decline of 0.6% on December.

www.bbc.co.uk

It looks to me like underlying inflation is getting back under control in the US, core inflation is dropping there, but I wouldn't rule out further rate rises.

Inflation is absolutely hammering the UK, I think it's being exacerbated by Brexit effects, but should calm down this year. The pound is up over 10% since the Truss clusterfuck, which will help, as will reduced input energy costs, but due to the fucking idiotic structures the UK has put in place for energy markets, consumer energy prices probably won't start to decline until about June. Unless they actually change those structures.

Eurozone core inflation is dropping fast, 8.5% down from 9.2%, and because storage levels are still very good, still at ~80%, it's likely the worst has past for energy driven inflation, unless Feb/Mar are very, very cold.
That said, ECB rates are still low, would expect another few rate hikes.


*In my opinion, this is indeed fucking stupid: https://www.ofgem.gov.uk/publicatio...sation Charge (MSC,wholesale price cap index1.
"The Market Stabilisation Charge (MSC) temporarily requires all domestic suppliers acquiring a domestic customer to pay a charge to the losing supplier, when wholesale prices fall considerably below the relevant wholesale price cap index
...
As of 23 May 2022 the MSC will be initially triggered when the wholesale cost falls more than 10% lower than the wholesale cost element of the price cap. The MSC also includes a derating factor, currently set at 85%. This de-rating factor determines the proportion of nominal hedging losses beyond the trigger point that will be covered by the MSC"

Basically, if the wholesale price falls and companies want to use that opportunity to start reducing prices to customers, they have to pay 85% of the difference to the company losing the customer, effectively killing off any reason for competing.
In belated, unrelated news, Centrica reported an 8x increase in earnings a few weeks ago, has brought back its dividend and is engaging in a quarter billion pound share buyback. https://www.theguardian.com/busines...fold-rise-in-earnings-amid-soaring-gas-prices
Which is nice.

 

[Stacky]

Shell has just reported its highest profits in its 115 year history.

They made £32.2 billion in profit in 2022

Have their costs gone up?

No.

Kerrrrrching.................................

 

[How bad boy]

Looks like Silicon Valley Bank is in serious trouble.

When I read the explanations why, it's bleedingly obvious that this has been coming and will be a problem with other banks too.
Fundamentally, they got a massive influx of deposits in recent years. They put it in Mortgage Backed Securities.

Their average yield is 1.56-1.66%.
The Fed funds rate is ~4.5%

The value of those Mortgage Backed Securities has dropped because, well, why would anyone buy them when the (almost) risk free return from the Fed is 3x the return?
They still owe those deposits back to people who gave them the money. But those deposits have been invested in MBSs that are worth less than they paid for them. Almost 10% less, based on sales on Wednesday.

As a result, people are looking at them and thinking:
"Are they still a viable bank, because their assets are worth less than they owe people in deposits? Hmm, best get my money out of there while I still can"

Which means that short term, they may not have enough money on hand to actually pay for all those withdrawals, or maybe hold a fire sale of those MBSs, realise more losses, just to cover the withdrawals.
That is a bank run. Which is generally considered a bad thing.

https://twitter.com/x/status/1633956163565002752

They tried to fix this by raising $2bn+ in new capital from the market.

Their share price dropped off a cliff as a result:

https://twitter.com/x/status/1634177463382077440

A 10 year mortgage rate is priced using the 10 yr interest rate swap (fixed v floating).

This 10 year interest swap curve is calculated using Libor rates going out 10 years, which is totally based on future expectations.

Therefore at day 1 there will be no difference in which mortgage you choose, as no one can tell the future you will either benefit or not depending on how accurate these interest rate expectations prove to be.

Generally banks will sell government bonds they are holding to hedge against giving you a fixed rate. i.e they sell a bond in which they receive a fixed coupon from the government in return for receiving a fixed payment from you, but at a higher rate than the government bond albeit with more credit risk involved, or they will take the other side using interest rate swaps, i.e they pay fixed (10 yr rate) but receive floating (3 mth libor) to another bank which is offset by receiving fixed from you combined with paying floating on a daily basis ( borrowing short term) to finance the mortgage they gave to you. Really the only way they should lose on mortgages is if you default or they are not properly hedged.

Competition as you mention will only eat into whatever extra margin they charge customers as opposed to the market rates they deal with other banks.

About that...

 

[How bad boy]

Worth pointing out that the assets backing the mortgage market, i.e. houses, are declining in value in many countries (e.g. UK) right now.

Does any of this sound familiar?