The Fed Admits the Economy is Slowing

The Federal Reserve hiked interest rates by 0.75% on Wednesday, which was largely expected by market participants ahead of the announcement.

On the call following the Fed’s announcement, people were dying to ask Fed Chair Powell about the weakness in the economy, and Powell admitted that the economy weakened in the second quarter.

The Fed‘s dual mandate requires it to maintain price stability, and the inflation data is far too hot for them to ever consider not raising rates. Since we’re still creating jobs in the economy, that gives them cover to keep raising rates until inflation comes down. However, today’s discussion provided good clues as to Powell’s mindset, or at least how I viewed his topics of conversation.

First, here is the official statement of the fed:

Recent spending and production indicators have eased. Nevertheless, job growth has been robust in recent months and the unemployment rate has remained low. Inflation remains high, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices and broader price pressures. Russia’s war against Ukraine is causing enormous human and economic hardship. The war and related events are creating additional upward pressure on inflation and weighing on global economic activity. The Committee pays close attention to inflation risks.

Breaking this down, Powell said that consumer spending, housing construction and fixed business spending had eased. Looking ahead, Powell said the Fed wants to see “convincing evidence that inflation is moving lower.” To me, that’s the biggest statement of the day because it sounds like a man trying to blink.

Powell also said the pace of these increases “will continue to depend on incoming data and the evolving outlook for the economy.” My take on this, and why the 10-year yield is lower than recent highs, is that the bond market knows the economy is weakening while the Fed keeps going higher. This means the Fed is moving into recessionary data.

The Fed has always been talking about how prices have risen due to the Russian invasion of Ukraine, and some of that heat has fallen on some of the commodity prices of late, such as: B. the wheat prices. Now we see that copper prices are also falling more significantly. When copper prices fall aggressively, it doesn’t bode well for the economy, particularly for housing.

The Fed is trying to achieve price stability, but it doesn’t really have the tools for some of the supply tightness. Higher mortgage rates have created more supply for the existing housing market. However, higher rates have halted construction for this extension as well. This will continue until interest rates drop again after homebuilders clear the backlog of houses they need to build.

Oil prices are not really controlled by the Fed here as the US dollar is already super strong. In the past, this would have affected oil prices, but due to other factors such as the Russian invasion, that is no longer the case, the Fed noted.

We’ve seen commodity prices fall recently. But we still have the X variable of the Russian invasion and possibly China wreaking even more havoc with Taiwan. What if we get more aggressive commodity prices due to supply constraints: does the Fed continue to hike knowing it can’t control that aspect of inflation?

Powell has admitted that rate hikes alone can’t really bring oil prices down. A simple way of looking at it is that when the US enters a recession with job losses, fewer people drive to work every day. That’s not a popular statement for the Fed to make, so don’t expect them to say it any time soon.

Powell even spoke about how the Fed would like to see a growth slowdown:

“We think there is a need to slow growth.”
“We believe we need a period of below potential growth.”
“We believe that in all likelihood there will be some relaxation in the labor market.”
Welcome to the party, buddy, we’re already there.

Watching Powell, I have a feeling the Fed is aware of the slowdown, but the jobs data gives them cover. If we were to lose jobs, then I think the narrative of the Fed‘s rate hikes would change.

Powell kept talking about the slowdown in the second quarter, and the leading economic index peaked in May this year. Against this background, the bond market is right here. The 10-year yield is much lower than the recent high of 3.50%, reflecting the fact that growth is slowing. and if things get worse, the Fed will change tack because it admitted today that some of the second quarter data shows real weakness.

I don’t think Powell wants to say that openly because he’s afraid of falling interest rates and rising stocks. We’re going to get into the data-driven dance from now on, and the tiptoeing talk of recession, expansion, and which of their mandates is more important: jobs or inflation. Inflation is clearly the top priority at the moment.

So how does this Fed action affect mortgage rates?
With the Fed aggressively raising rates, why have mortgage rates fallen from recent highs of over 6%? As we all know, mortgage interest prices have come under a lot of pressure in recent months, rising slightly above the historical norm due to its relationship to the 10-year yield. Some of that wild pricing comes from a stressed market, but generally, as the 10-year yield rises, rates rise and vice versa.

The 10-year yield recently rose as high as 3.50% but went as low as 2.72% on Wednesday, a noticeable reversal in bond yields.

The bond market reaction on Wednesday was not at all surprising, although some people believed mortgage rates and bond yields would rise sharply after the news. The bond market has been ahead of the Fed‘s rate hikes and it seems to me that for now the market is assuming the Fed will be less aggressive going forward.

The Fed admits the economy is slowing appeared first on HousingWire.

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Summary

The Federal Reserve hiked interest rates by 0.75% on Wednesday, which was largely expected by market participants ahead of the announcement.

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