Fed rate hikes: Cause for pause?
Fed watchers see potential for a pause in rate increases, but recent reports show the economy still runs hot.
The most significant economic news last week came from the March FOMC meeting, where the Fed raised the fed funds rate another 25 basis points and indicated that, as of now, one more such rate hike is planned. In his press conference, Fed Chair Jerome Powell said the Fed will be monitoring lending standards as sustained tighter lending standards “could easily have a significant macroeconomic effect, and we would factor that into our policy decisions.”
In housing news, existing home sales surged in February after January’s dip in mortgage rates, while new home sales also climbed to a much smaller extent. Still, after consistent and significant declines last year, the level of total home sales in February was low.
Existing home sales surged in February after 12 straight months of declines.
A dip in mortgage rates likely influenced February’s jump in existing home sales, but rates rebounded in March.
As has been the case in the past, the current banking crisis should weigh negatively on consumers’ confidence and sentiment. The preliminary reading for the March University of Michigan consumer sentiment showed a moderate drop to 63.4 from 67.0 in February. However, over 85 percent of interviews were conducted prior to the collapse of Silicon Valley Bank on March 8. As such, we look for consumers’ sentiment to have eroded further, with the index falling to 62.0. Consumer confidence will likely follow suit. The drop in consumer confidence in February was heavily driven by the expectations component, as reports for future business conditions, job availability, and income all suggested diminishing economic activity. However, the resilience in the labor market might buffer a stronger fall for now.
The Case-Shiller home price index likely falls for a seventh straight month in February, dropping another 0.5 percent. This would markedly lower the year-on-year rate of change to 2.5 percent from 4.7 percent in January. The downward path would follow the decline recorded in existing home prices, which turned negative on a y/y basis for the first time since February 2012. The good news is that eventually slower home price inflation will feed into slower increases in residential rent prices and overall inflation.
While there have been nascent signs of the very tight labor market easing a bit, the number of jobs created in February exceeded expectations again. However, encouragingly the labor force participation rate for working-aged people has risen back to its pre-Covid levels. The modest softening in labor conditions is leading to a moderation in wage increases. In the February, the average work week fell back to 34.5 hours after expanding to 34.7 hours in January. Thus, despite still strong employment growth, slower wage gains and a drop in the average hours worked will lead to just a modest 0.2 percent increase in personal income in February following a sturdy 0.6 percent advance in January. Consumer spending likely rises 0.3 percent on the month, driven by continued solid spending on services and non-durable goods spending that offset a large drop in durable goods spending. Our estimated modest increase in overall spending would be down sharply from ebullient 1.8 percent advance in January. The headline PCE price and core PCE price indexes should each rise 0.4 percent in February based on the already reported CPI performance. This should only allow the year-on-year pace for overall consumer inflation to ease slightly to 5.2 percent from 5.4 percent, while the core consumer price measure remains unchanged at 4.7 percent y/y.
The FOMC instituted a hike in the fed funds rate of 25 basis points at the conclusion of their meeting last week. Fed Chair Jerome Powell said the Fed “will closely monitor incoming information and assess the implications for monetary policy — some additional policy firming might be needed.” As it is, the Fed’s projected terminal rate of 5.1 percent was left unchanged in its latest Summary of Economic Projections (SEP). The FOMC’s dot plot estimates indicate that 10 of the 18 FOMC members agree with the current projection of one more rate hike and they are done tightening this cycle — one and done. One official already sees them having reached the terminal rate, while seven others see higher rates, with one seeing 5.875 percent — higher than 5.6 percent in December dot plot.
The FOMC recognized in the policy statement that the fallout from the banking crisis will lead to tighter credit conditions for households and businesses and that will weigh on economic activity, employment, and be disinflationary. How much is uncertain. This is all in line with our view, but ultimately the tightening of lending standards, which were already tightening, will lead to a moderate recession unfolding in the second half of this year. If the ensuing reduction in bank credit lending is severe — a full blown credit crunch — the recession could be deeper and unfold quicker than we have been forecasting. The bond market has dramatically reduced its expectations for the future path of the Fed’s policy rate — it now prices in about one full percentage point cut in the fed funds rate by year-end.
Relative to recent sales numbers, there was a flurry of activity in the market for existing homes in February. The rise in sales was the first since January 2022 and the largest since mid-2020. The seasonally adjusted annual rate of existing home sales was 4.58 million units; while it is a five-month high, it remains at a low level. Sales continue to be held back by a low supply of existing homes for sale as well as banks tightening lending standards. New home sales climbed in February and remained well above their long run average as the low inventory of existing homes continues to boost demand in the market for new homes.
Single-family homes were at their most affordable in January (when most of February’s existing home sales would have gone into contract), likely resulting in the large jump in sales. But affordability is still low in an absolute sense and mortgage rates began to climb again in the second half of February and into March, so the relative strength seen in February’s numbers could be short-lived. Moreover, even if mortgage and home prices trend lower as the economy heads into recession, the fear and actual rise in unemployment will dampen home buying activity.