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Let the Unwinding Begin!

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The Federal Reserve gave the markets what they wanted, and more, this week. As expected, the Federal Open Market Committee (FOMC) announced the long-promised balance sheet normalization program will begin in October. The Fed will allow $10 billion in Treasury and mortgage-backed securities to run off each month, with quarterly increases until the monthly total reaches $50 billion. By this time next year, the balance sheet will be shrinking by $600 million per year. Even a back-of-the-napkin calculation reveals the Fed has a long way to go. This gradual and predictable process should have little impact on the bond market and the economy – at least, that is the FOMC’s intent. The Fed also announced the likelihood of another fed funds rate increase this year and potentially three in 2018. While the Fed believes economic growth will continue to increase at a moderate pace, it still maintains the need for slow and steady rate increases to keep the economy on track. The long-term rate projections were reduced by 25 basis points to 2.75 percent past 2020. Fed funds futures are predicting a 63 percent chance for a December rate move, up 30 points from a month ago.

Other Key Indicators this Week:

Housing – The story is the same…rising prices and a lack of inventory continue to dampen the housing market. Sales of existing homes declined 1.7 percent in August to the lowest level in a year. The number of homes for sale decreased 6.5 percent from a year ago. This marks the 27th consecutive year-over-year decline. More than half the homes for sale sold in less than 30 days, and the median price of a home increased 5.6 percent. The August report gave us the first look at the effects of Hurricane Harvey. Purchases in the Houston area fell 25 percent from a year ago versus what would have been an unchanged level, according to National Association of Realtors’ chief economist. Most economists believe the impact from the hurricanes will not have a permanent negative effect on the economy, but with a housing market already facing pricing and supply issues, the near-term impact will hamper any chance of improvement this year.

Homebuilders are not feeling as confident as they were a month ago. The National Association of Home Builders sentiment index fell three points to 64. The outlook for current and future sales declined, as concerns grow over rising costs for materials and a shortage of available workers in the aftermath of Hurricane Harvey. Construction on new homes declined 0.8 percent in August. The data collected included only 60 percent of the cases in Texas and Florida, compared to the usual 95 percent. The only glimmer of hope in the construction report was a 5.7 percent increase in building permits. The increase was the largest since January.

Strategically for Credit Unions:

As the Fed begins the process of removing the last tool of monetary stimulus, interest rates should move higher, and spreads on mortgage products should increase as more bonds become available. "Should" is the operative word. After Wednesday’s announcement, yields on both the two- and 10-year Treasury notes increased at the same pace, up five basis points. The Fed’s reduction of interest rates in the longer term is keeping a lid on 10-year yields for now.  The market is not 100 percent convinced the economy will continue its moderate growth, given higher loan rates. By one economist’s calculations, the spread between 30-year mortgages and 10-year Treasuries will widen, pushing mortgage rates up by an extra eighth-of-a-point.

Sarina Freedland –Senior Investment Officer

Although this information has been obtained from sources we believe to be reliable, we do not guarantee its accuracy, and it may be incomplete or condensed. This is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. All herein listed securities are subject to availability and change in price. Past performance is not indicative of future results. Changes in any assumption may have a material effect on projected results.