May 2023
The Fed paused! Following ten consecutive rate hikes, the FOMC refrained from raising the federal funds rate at the June meeting. The summary of economic projections of the committee members offers some insight into their thinking. Despite leaving the overnight rate unchanged, the committee raised its Fed Fund forecast for the end of this year to 5.4% – 5.6%, an indication that they believe additional hikes will be warranted. What likely drove that decision was the lowered forecast for the unemployment rate from 4.5% to 4.1% and the forecast for real GDP revised for this year from 0.4% up to 1.0%.
In the post-meeting press conference, Chairman Powell made it a hawkish pause by saying, emphatically, that we’re “talking about a couple years out” for a rate cut. Additionally, he emphasized that the pause was just that and not a movement to a new rate cycle paradigm.
We find it useful to also pause and evaluate the current economic situation and determine if the Fed is going to be successful in engineering a soft landing. First, and foremost, inflation is coming under control as the May consumer price index rose 0.1% from the April reading. That, no doubt, is a short-term victory. But the year-over-year measure is 4.0% higher than May 2022, double the FOMC target and not such great news. But it is moving in the right direction and less than half of the 9.0% YOY rate recorded last June.
What is amazing is the Fed has been successful in slowing inflation without materially damaging the economy. Unemployment has ticked up from the 3.4% low reached earlier this year, but only by 0.3% to 3.7%, which is arguably below the non-accelerating rate of unemployment, a measure that once was of crucial concern to the central bank. Instead, the Job Opening and Layoff measure indicates that there are more than ten million jobs available and unfilled, which would argue that the Fed rate hikes have done little to slow the economy.
Similarly, Gross Domestic Product has stayed above zero since the two consecutive quarters of negative outcome in the first half of 2022. We attribute that stability to the durability of the jobs market. With the tightness in the labor force employers have been reluctant to lay off workers and, as such, that is supportive of retail spending.
The one downside to the rising rates has been the housing sector. Housing starts peaked in early 2006 at a 2.2 million annual rate of new home building. After collapsing to less than 600,000 annualized units in 2009, the measure rebounded to 1.8 million units last spring, only to collapse back to 1.4 million units in April of this year. Despite the slowdown in home construction, house prices have remained fairly stable according to the Case-Shiller 20-city housing index. After soaring for years, propelled by the ultralow interest rates environment, the index registered the first year-over-year price drop since May 2012, a -1.15% contraction. The anecdotal reason for the relative price stability despite the slowing activity is that most homeowners have a sub-3.5% mortgage rate and are disincentivized to move to a new home and incur a higher mortgage rate. The commercial real estate market appears to be the area of most concern with vacancies elevated and higher interest rates coupled with tighter credit conditions available from banks. We are watching to see how this dynamic interacts with economic activity and thus the Fed’s future rate path.
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