With the next meeting of the Fed just ahead, interest rates are drawing a lot of attention, especially with the recent upward tick in longer-term maturities. The US inflation has come down significantly since May 2023 and has hovered around 3% - 4.1% with 3.7% currently. The aggressive hikes in the past have pushed the federal fund rate up to 5.25% on the lower end, which is now substantially higher than the inflation rate. Figure 1 shows the development of both since 1994 and the recent shift. The US core PCE as an alternative measure of inflation (excluding food and energy) has also reached 3.7% for the first time since May 2021 and is an arguably more important factor for the Fed in the determination of their rate. With this positive development, it is unlikely that another hike is necessary in their November meeting. This notion is strongly supported by market participants, who see the chance for a rate increase at a probability of close to zero.
Bonds have experienced substantial volatility since Covid-19. Back in March 2020, the 30-year US treasury yields fell below 1% for the first time in its history. With the high interventions from the central banks, bond yields have risen steadily, albeit mostly at the lower end. However, the longer end also began to increase and has passed the 5% mark for the first time since 2007, as shown in Figure 1. Nonetheless, this still has not shifted the yield curve back to a normal state, as the 3-month treasury bill is still yielding more at 5.63%. This development also caused the longest and steepest bear market in the bond ecosystem. Measured by the Bloomberg US Aggregate Bond Index, the bear market is now in its 38th month and has resulted in losses exceeding 17% in this time period. In conjunction with rising interest rates, mortgage rates also skyrocketed. 30-year fixed mortgage rates increased from 2.65% in 2020 to more than 7% currently, as shown in Figure 2. The last time, mortgage rates were at such levels was during the dot-com bubble. This has led to a substantial impact on the real estate market. With housing becoming that expensive, many people can no longer afford houses. Consequentially, in the US, mortgage applications have fallen to the lowest levels since 1995. Similarly, construction of apartment buildings also collapsed by more than 40%, which corresponds to the steepest fall since 2010. While financing costs are a significant contributor to this decline, it is also negatively affected by a relatively high vacancy rate and a decline in rent level, due to excess supply.
Rising oil prices have been in the news frequently over the past weeks. Back in July 2023, WTI crude oil was below $70 per barrel and has temporarily claimed above $95 per barrel as of the end of September 2023. Price levels have now reached heights last seen almost a year ago, as shown in Figure 1. The latest surge in price was likely caused by continuously declining reserves, which also reached a low point in more than a year. Previously oil prices have been mostly rising, due to production cuts by OPEC+, which was a response to the decline in oil prices the year before. The latest spike was further strengthened by further voluntary cuts by Saudi Arabia and Russia, which are likely to be maintained until the end of the year. Price estimations on oil prices towards the end of 2023 hover around $95 to slightly above $100 per barrel.
The current economy remains under pressure and recession talks mostly vary based on their expected impact and when they occur. In the US, interest rates remain high at 5.25% with moderate inflation at 3.2%. While inflation seems to normalize, it rose compared to June 2023, which led to another hawkish view of the Fed and further rate hikes are not unlikely. The yield curve inversion of 2Y-10Y yields is especially worrying, as the inversion has persisted for about a year now and economists expected an elevated likelihood of a small to medium recession. In Europe, the situation is more tense, as present headwinds, such as energy and the war in Ukraine, do not seem to evaporate quickly. As a consequence, inflation is coming down more slowly than in the US. In the EU, inflation remains at 6.1% and 6.8% in the UK with interest rates at 4.25% for the EU and 5.25% in the UK. Figure 1 summarizes the development of interest rates and inflation in the US, the EU, and the UK. In Europe, the economic growth is concerning, as the estimated GDP growth in the EU is only 0.6% in Q2 2023. In the UK, the situation is more dire, as the economy has remained close to flat since Q2 2022.
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