All I want for Christmas
Temperatures in central Ohio dropped briefly last week, providing a gentle reminder that we have passed the 100-days-until-Christmas mark. The cool breeze was also perhaps due to Mariah Carey thawing out and getting closer to our radio stations, bringing with her the hit song full of things she may trade for a Christmas wish. “I don’t want a lot for Christmas, there is just one thing I need,” she sings. Presumably, it was lower rates. Unfortunately for Mariah and mortgage bankers alike, the macro narrative is not working in favor of that wish.
Inflation, Federal Reserve (Fed) policy, economic growth, Treasury supply, and fiscal deficits all complicate the picture. For the moment, inflation seems to take the lion’s share of concern, as the Federal Open Market Committee (FOMC) hiked rates last week, marking the Fed’s first rate increase since 2023. Furthermore, Fed officials are projecting at least one more increase this year amid expectations that inflation will not subside in the near term.
Here are four key takeaways from the FOMC’s post-meeting statement and Fed Chairman Kevin Warsh’s press conference:
- The Fed raised interest rates for the first time in more than three years to return inflation to its 2% target in a “timelier” way.
- Policymakers also projected another rate increase before the end of 2026 and removed an expected cut in 2027. They now see the Fed holding rates steady next year.
- In his press conference, Warsh emphasized that the economy is strong and said that the hike removes a “dose of accommodation” from policy. That framing signaled that, in his view, the Fed is already accommodative and likely needs to move toward neutral.
- The Fed’s decision was unanimous, and the projections in the dot plot show strong backing for at least one more hike, with 16 officials seeing that as likely.
Warsh additionally outlined three things that have happened since the July meeting to offer some “backward guidance”:
- Data suggest the economy has strengthened.
- Inflation trends “weren’t passing the test.”
- Geopolitics: “There is no hiding from hot spots around the world, and our judgment about what is the most likely, or least likely, geopolitical situation has changed.”
While the geopolitical implication is vague, one interpretation is that policymakers have concluded the Iran war will be ongoing—thereby keeping energy and transportation prices high and maintaining upward pressure on inflation. Warsh also acknowledged concerns over the U.S. budget deficit, which Treasury Secretary Scott Bessent has also cited as a contributor to rising interest rates.
Warsh remained reluctant to tip his hand on the central bank’s next move. But in a speech last month, he said the Fed would “have work to do” if it could not “be confident that underlying inflation is moving to our objective, clearly and at sufficient speed.” At last week’s press conference, Warsh had an opportunity to expand on his earlier comments. “This summer’s inflation readings do not tell me that underlying trends have meaningfully improved,” he said. Taken together, it is reasonable to expect further rate hikes in the near future.
As mentioned, FOMC participants largely expected one more hike this year and were mostly flat on expected hikes in 2027. This rate movement would clearly be predicated on improvements in inflationary pressures, yet that may prove to be just a Christmas wish.
We analyzed how inflation changed after the first rate hike in a cycle and after the final hike, using past hiking cycles dating to the 1970s. As Figure 1 shows, two years after an initial hike, inflation was higher than where it started. This points to two things: 1) the long and variable lags with which the economy responds to monetary policy; and 2) the “asymptotic” reaction function at the Fed, whereby policymakers are typically quick to ease but slow to tighten.
The same analysis revealed that inflation tends to fall only after the final rate hike has been completed. Intuitively, hikes throughout a cycle have cumulative power, and only after enough have been completed can policy achieve its desired outcome, albeit often with a recession or period of slow growth.
Nevertheless, last week’s hike seemed to be well received by the broader investment community. Tracy Chen, a portfolio manager at Brandywine Global Investment Management, wrote: “I think the 25-bp hike regained credibility for Chair Warsh, as shown in the bull flattening. He listened to the market as he always said.” While the immediate aftermath of the hike was sloppy—reminiscent of the “buy the rumor, sell the fact” mantra—the balance of the week went as expected, with a bull flattening of the curve, as Chen noted.
Warsh also seemed to try to get ahead of any backlash from the White House. “The decision we made today was a sober decision, serious decision, responsible decision, one that we have been preparing for and thinking about in my hundred and ten or twenty days here,” said Warsh. Before President Trump had a chance to comment, White House spokesman Kush Desai said, “Today’s rather unfortunate decision by the Federal Reserve to hike interest rates was not, from the administration’s point of view, backed by a particularly compelling economic case.”
President Trump later took to social media to argue that sovereign borrowing costs should be more like corporate bond yields, with the better credit carrying the lowest rates. The president posted that U.S. rates “should be 1%, or less” because “Our Country is BOOMING with new Investment” and has “the Best Credit in the World…. LOWER THE INTEREST RATES FOR THE UNITED STATES OF AMERICA, AND FAST!”
While the president’s message did not mention Warsh by name, the post likely increases pressure on the Fed chair, even though Trump encouraged Warsh to be “totally independent” during his swearing-in ceremony. When asked if he had any recent communication with the president, Warsh was aloof. History also suggests that the Trump-Warsh relationship may endure far more stress in the coming months.
Past rate-hike cycles, dating to the 1970s, suggest an average of 11 total hikes, amounting to an average of 537 basis points (bps) (Figure 2). The median total, though, is only 387 bps, which highlights the skew from the large swings of the late 1970s. The shortest cycle consisted of six hikes in the lead-up to the tech bubble, amounting to just 175 bps. Perhaps more important to our market, the reaction function of the 10-year Treasury note is largely bearish once a rate-hike cycle begins. On average, the 10-year note yield is 80 bps higher two years after the start of rate hikes. Similarly, two years after the final hike, the 10-year yield is lower by about 150 bps.
There is some solace in these cycles, however. As noted, the shallowest rate-hike cycle occurred just before Y2K, when the Fed hiked by only 175 bps in total. That cycle was accompanied by a sympathetic increase in the 10-year note yield. But after just one year, the 10-year yield began to reach parity with its level at the start of hiking and then moved lower in subsequent months. This pace was much abbreviated from historical norms.
Still, the path of least resistance today seems to be following the historical guide. A major turning point for monetary policy and rates will be how far Warsh and company can raise rates to quell inflation without harming the labor market. Running the same analysis with employment presents a sobering view: while rate hikes begin when the job market is healthy, once the cycle ends, it takes only a couple of months for job losses to begin.
If Mariah reissued a new rendition of her beloved song this fall, perhaps she would close with: “All I want for Christmas is an end to war, lower inflation, fiscal restraint, and a steady labor market.” But we concede it doesn’t rhyme well.
FROM THE DESK
Agency CMBS — Last week, rates remained challenged and the 10-year Treasury note yield maintained tight proximity to the psychological 5% mark. Fannie Mae DUS new issue volume was low, at around $450 million. Surprisingly, Ginnie Mae volume was within striking distance. Spread-wise, Fannie Mae origination was flat, week over week, and Ginnie Mae was around two bps wider.
Municipals — Municipal bond market conditions continued to weaken, as AAA tax-exempt yields moved significantly higher on the front end of the curve; the long end was largely unchanged. The selloff was driven by a combination of rising Treasury yields and continued heavy new-issue supply. Although October reinvestment flows should begin to provide some technical support in the coming weeks, available reinvestment capital is expected to be meaningfully lower than levels seen during the summer. Mutual funds experienced their first weekly outflow since mid-April, with approximately $1.8 billion leaving the asset class, including $584 million from high-yield municipal funds. If issuance remains elevated and fund flows continue to weaken, market technicals will likely stay challenged, placing additional pressure on new-issue pricing and contributing to wider credit spreads.
The information contained herein, including any expression of opinion, has been obtained from, or is based upon, resources believed to be reliable, but is not guaranteed as to accuracy or completeness. This is not intended to be an offer to buy or sell or a solicitation of an offer to buy or sell securities, if any referred to herein. Lument Securities, LLC may from time to time have a position in one or more of any securities mentioned herein. Lument Securities, LLC or one of its affiliates may from time to time perform investment banking or other business for any company mentioned.
