The federal funds rate has skyrocketed 5.25 percentage points since March 2022, taking Treasury yields higher and the 30-year mortgage rate to 8% in October.
The dramatic increase made homes increasingly unaffordable, disappointing would-be homebuyers.
Although mortgage rates remain high, they've recently declined, to below 7%. The rate drop has surprised many market participants — but not longtime fund manager Doug Kass.
Kass is a hedge fund manager with more than 40 years of experience navigating markets, including as director of research for Leon Cooperman's Omega Advisors.
On Oct. 20 Kass accurately predicted that rates would fall, when he selected the 20-year Treasury Bond ETF as his "Single Best Trade."
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Since then, the 10-year Treasury note yield, which banks use to set mortgage rates, has fallen to 3.9% from 5%, causing rates on 30-year mortgages to retreat. (Bond prices and yields move inversely to each other.)
Kass's uncanny forecast suggests that investors might do well to pay attention to his outlook for interest rates in 2024.
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The Fed's inflation war hits a turning point
The Federal Reserve has a dual mandate to set interest rate policies at levels that maintain low inflation and unemployment. That hasn't been easy over the past few years.
The central bank in 2020 enacted a zero-interest-rate policy to get people back to work after covid lockdowns caused unemployment to soar. Then, in 2022, it embraced the most hawkish rate hikes since Paul Volcker in the 1980s to quell inflation after easy-money policies and supply-chain disruptions caused inflation to skyrocket.
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Higher prices and borrowing costs have forced many households to shift spending away from discretionary purchases to necessities. It's also caused many companies to retrench expansion plans, slowing the economy.
Gross domestic product slowed in the first half of 2023, reducing corporate profits, before rebounding in the third quarter.
Meanwhile, homeowners who were reluctant to give up covid-era sub-3% mortgage rates and surging monthly mortgage payments have caused home prices to climb and home sales to fall.
According to the National Association of Realtors, in November existing-home sales were down 7% and median home prices increased 4% from a year earlier.
The good news is that the Fed appears to be winning its inflation war, which may eventually lead to lower rates.
Inflation briefly rebounded this summer, but the consumer price index, a closely watched measure of inflation, slowed to 3.1% year-over-year in November. That starkly contrasts with its nearly double-digit growth in June 2022.
Rates may struggle to go lower next year
A self-described contrarian with a calculator, Kass often finds himself at odds with conventional wisdom.
His prediction that bonds would rally in October, sending yields lower, came when most believed that rates were destined to continue marching higher.
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Now that bonds have made a big move higher and many have turned bullish on them, he's tilting the other way, predicting that yields won't make much more progress lower.
In Kass's annual "10 Surprises" list for the coming year, he outlined a relatively bearish outlook, suggesting inflation proves too sticky for rates to fall.
"Inflation fails to tick much lower, remaining well above the Fed's target," writes Kass. "The yield on the 10-year Treasury, which today is at 3.91%, never declines below 3.75% and fluctuates between 3.75% and 4.75% most of the year.
"A developing US recession, late in the year, sends the budget deficit as a percentage of GDP to 10% or more — overwhelming Treasury supply and sending the 10-year yield back above 5%."
Federal Reserve rate cuts remain likely in 2024
Despite Kass's belief that a stronger economy in China will underpin crude oil prices, contributing to inflation in 2024, he still expects the Fed to cut rates twice before July.
Wall Street analysts agree, as does the Fed's own Summary of Economic Projections, which suggests three rate reductions next year.
UBS analysts expect rate cuts to be driven by increased unemployment, leading the federal funds rate to finish 2024 at 2.5%. Goldman Sachs anticipates five 0.25-percentage-point rate cuts in 2024, including three early in the year and two thereafter.
"We see the committee delivering at least three back-to-back 25-basis-point cuts, probably in March, May, and June," said Jan Hatzius, Goldman Sachs chief economist.
Those rate cuts should be good news for mortgage rates, but only if Treasury yields aren't driven higher by a flight to safety due to a souring economy.
Kass unconvinced of a soft landing
Kass isn't convinced that the economy will experience a soft landing — easing inflation and no recession. If he's right, economic worry could offset the Fed's efforts, pushing up the yields used to set mortgage rates.
"There is neither a soft landing nor a hard landing — just very sluggish real growth in the U.S. economy," says Kass. "The U.S. federal debt problem is no longer shrugged off by investors — it looms larger in late 2024 and slowly becomes a serious systemic problem in the years ahead."
Overall, Kass predicts "creditors demand more to buy U.S. debt," leading 10-year Treasury yields to touch 5.5%. If that happens, Kass expects the central bank to stop selling and start buying bonds on its balance sheet in a bid to keep rates from going any higher.
Since mortgage rates historically run 2% to 3% above the 10-year Treasury yield, Kass' prediction will likely disappoint would-be homebuyers.
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