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If you’re like me and tend to obsess a bit over macroeconomic data and news, you may have noticed that over the last 2 years, most of the time you hear negative economic news, we actually get a boost to the stock market and lower bond yields with corresponding lower interest rates.  What’s the story?  Why would bad news be good for markets?

If we boil down the metrics a bit and think about their underlying effect on investors’ future expectations of the economy, this confusing interplay starts to make sense.  The last 2+ years of business and economic news has been dominated by the debate over the course of inflation.  The effects of inflation on consumer and company behavior has wide ranging implications for businesses and real estate in the economy.  Inflation is a drag on spending as prices rise at a faster pace, forcing workers to demand higher wages and companies to charge higher prices for goods and services, igniting a vicious cycle which historically can be extremely difficult to tame.

Enter the Federal Reserve.  In the service of a stable long term economy, the Fed has a dual mandate to promote maximum employment and stable prices.  The Chair and Board of Governors of the Federal Reserve have the unenviable task of influencing monetary policy and balancing these sometimes competing priorities by the setting of interest rates through control of the overnight Fed Funds Rate.  Conventional thinking suggests that by increasing interest rates, making money more expensive cools demand throughout the economy and relieves pricing pressure, calming inflation.

This can be a double edged sword though.  Raise interest rates too high too fast and you risk eroding the other side of the mandate, maximum employment, by increasing the cost of labor and anything else bought with debt.  So the Fed must chart a rate path that by their judgement is most likely to result in decreased demand through higher rates, but not so much as to cause a significant rise in unemployment and with it, recession.  This is the much vaunted “soft landing”.

In a perfect world, the Fed could act on instantaneous data and witness instant results.  However, the real world moves more slowly.  They’re forced to interpret data that can be a year old to determine what’s happening today in order to set policy that will impact the data into future quarters and years. The Fed also doesn’t set long term interest rates. While the overnight funds rate impacts rates throughout the financial system, real estate loans generally price off of longer term US Treasury debt, the main benchmark being the 10 year treasury yield.

Treasury yields fluctuate by the minute as participants in the bond market buy and sell the debt. Depending on the going price for a bond at any given point, the yield will be higher or lower. As bond prices fall, yields rise, and vice versa. Because of this dynamic, the bond market is highly sensitive to news that investors think might influence interest rates in the future. In this sense, it’s really investor sentiment about the future that drives interest rates, and therefore mortgage rates.

With this structural thinking out of the way, let’s get back to the question at hand: Is bad news good?

If we examine a few recent data releases in the economic calendar through this sentiment lens, things become clear. Let’s have a look at a few this spring.
March 28th: US GDP was released and showed an annualized growth of 3.4% vs. an expectation that was forecast to be 3.2%
April 3rd: ADP Nonfarm Employment Change data for March was released showing 184,000 jobs were added to the economy vs. an expected 148,000 jobs
April 5th: BLS Nonfarm Payrolls added showed 303,000 jobs added in March vs. an expected 212,000 jobs added
April 5th: The unemployment rate was released showing 3.8% of the workforce out of work vs. an expected 3.9%
April 10th: Consumer Price Index (CPI) and Core CPI were released showing 3.5% and 0.4% year over year and month over month respectively, both topping estimates of 3.4% and 0.3%

Taken together, this is a whole bunch of really strong news for the US economy. GDP grew more than expected, the job market continues to create jobs at an aggressive rate while unemployment remains at 50 year lows. Great, right? Well, you’ll notice inflation has also remained elevated in the same stretch of days. This strong economic news coupled with the stubborn inflation reading was enough to send the yield on the 10 year treasury shooting up by 51 basis points from 4.20% on March 28th to 4.71% on April 25th, even though the Fed kept rates unchanged.

During this period from March 28th to April 19th, the S&P500 fell a full 5%, a huge move for such a short period of time. Interest rates shot up, continuing to cool sentiment towards real estate and adjusting equities sharply to the downside.

It certainly looks like a case of good news being bad, but is the reverse true? Let’s have a look at the few weeks immediately following our last data set.

April 25th: Preliminary US GDP for Q1 showed 1.6% annualized growth vs. expectations of 2.5%
April 30th: CB Consumer Confidence released at 97 vs. a forecasted 104
May 3rd: BLS Nonfarm Payrolls added 175,000 jobs vs. 238,000 expected
May 3rd: Unemployment released showing 3.9% vs. a forecast of 3.8%
May 9th: Initial jobless claims at 231,000 vs. 212,000 predicted
May 15th: Annual CPI at 3.4% as expected, but monthly CPI at 0.3% vs. a forecast of 0.4%

Quite the collection of bad news as compared to expectations, right? GDP slowed considerably, consumer confidence fell, way fewer jobs were added than expected, and unemployment rose. We did get one tiny piece of data in monthly CPI that suggested inflation cooled slightly. What happened to the equity and bond market? 10 year treasury rates fell 37 basis points and the S&P rose 6.8% to all time highs. Bad news was clearly good (for markets, at least).

We’ve been watching this confusing dynamic play out over the last 2 years since the Fed started it’s current interest rate tightening cycle.

As a real estate investor, it’s confusing to be rooting for bad news, but that’s the devilish nature of inflation. It forces us to hope that increased rates have taken their desired effect and cooled demand. Any indication that interest rate policy might be working can send assets that are dependent on debt financing like the stock market or real estate investments climbing in price as investors chase the wave of sentiment on the future.

Be careful what you wish for though. Although bad news certainly appears to be good for markets and real estate during inflationary times, that could change quickly if the economy were to tilt into recession.

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