by Jeff Weniger, Head, Equity Strategy, and Kevin Flanagan, Head, Fixed Income, WisdomTree
The mid-term elections are still more than eight months away, but that hasn’t stopped stories and headlines being posted about possible outcomes and what are perhaps the main drivers come voting day. Without a doubt, the number one issue appears to be the notion of affordability, and of course, what plans do the Republicans and Democrats have in store to address this issue.
One thing to remember, the U.S. consumer is still being confronted with the impact of the inflation surge coming out of the COVID-19 lockdown in 2021 through the spring of 2023. Yes, the inflation rate has fallen in considerable fashion from CPI’s peak annualized rate of +9.1% in June 2022 down to +2.7% by the end of 2025. However, that nine-percent increase didn’t disappear. The aforementioned 2021-2023 spike in prices remained intact. It’s just that the rate of price increases has declined. In other words, the current rate of inflation, while visibly below its peak, is still occurring on top of those spikes.
In order to see prices drop at the retail level, investors would need to actually see deflation. What we have currently is disinflation, or a slowdown in the rate of increase, not an actual decline in costs. Hence, for the consumer the affordability quotient remains front and center.
Where do interest rates fit into the equation? One of the Trump Administrations main talking points is to get interest rates down so housing becomes more affordable. We’re not going to talk supply and demand in this discussion, but rather, focus on mortgage rates.
Mortgage rates, such as the 30-year conventional fixed rate, is based on the Treasury (UST) 10-year yield. We all know the headlines surrounding the President and Fed Chairman, and Trump’s displeasure with this rate cutting cycle. However, it is important to note that all rates are not created equal. While the FOMC controls the fed funds rate, the UST 10-year yield is impacted by economic, inflation, and at times, supply considerations. History has shown they do not always move the same amount, let alone in the same direction. That’s how one gets a positive or steeper yield curve.
Another interesting headline surrounds the Trump Administration plan to potentially buy $200 billion in agency mortgage-backed securities (MBS). Once again, the goal here would be to bring down the UST 10-year yield, which would then hopefully, reduce the 30-year mortgage rate. It may seem a reasonable objective, but that UST 10-year yield will be more impacted by the macro-economic/inflation setting. Investors have witnessed this development during some of the Fed’s quantitative easing (QE) periods, where the ten-year yield actually rose despite the fact that the fed was buying Treasuries and MBS.
Could Treasury manipulate the yield curve and change/reduce auction sizes for longer-dated maturities? Not likely. For one thing, running a baseline deficit of nearly $2 trillion requires an ‘all hands on deck’ approach. At the recent February quarterly refunding announcement, the debt managers, once again, stated that coupon auction sizes are anticipated to be maintained at current levels “for at least the next several quarters.” Thus, no decreases, or increases for that matter, any time soon.
Treasury’s guiding principal is its preference for note and bond issuance to be “regular and predictable.”
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