The Federal Reserve’s policy-making arm, the Federal Open Market Committee (FOMC), issued a statement that seemed dovish, at first, but then the FOMC signaled that one more Fed rate hike was not only possible but likely. A survey of the FOMC members revealed that seven members did not want to increase key interest rates anymore, but they were overruled by 12 FOMC members who were open to another interest-rate hike. The FOMC statement said that members were “highly attentive to inflation risks.” The bottom line is that the Fed remains data-dependent, but that means any good news, such as rising GDP or higher energy prices, could mean another rate increase.
I remain in the camp that energy is an inflation outlier, so the Fed should not increase key interest rates further. The housing component (owner’s equivalent rent) in the Consumer Price Index (CPI) and wholesale service costs in the Producer Price Index (PPI) rose only 0.3 percent and 0.2 percent, respectively, in August. The primary reason why the CPI and PPI rose in August was that gasoline prices rose 10.5 percent and 20 percent, respectively.
There is nothing the Fed can do about the President Joe Biden’s energy policies, so I expect that the core rate of inflation will continue to moderate, giving the Fed no rational reason to keep raising key interest rates.
The other reason why I do not expect the Fed to raise key interest rates is that it risks squelching the “soft landing” scenario it proudly engineered. One example of high rates hurting growth is that credit card companies are now reporting a 3.63 percent default rate, up from 2.13 percent two years ago (in September 2021). Goldman Sachs is now forecasting that credit card losses will rise to 4.93 percent in late 2024 or early 2025.
In other words, consumer credit is expected to continue to deteriorate heading right up through the November 2024 presidential election. Several credit card companies are based in Delaware and have supported Joe Biden for decades. The fact that Capital One has backed Joe Biden in the past bodes poorly for his reelection prospects, since Capital One has historically had the highest default rates.
Across the pond, the European Central Bank (ECB) raised its key interest rate by 0.25 percent, to 4 percent, the eurozone’s highest level ever. In doing so, the ECB signaled that fighting inflation is more important than stimulating economic growth. Italy and Germany are big export economies, but due to China’s economic woes, they are contracting this quarter and will likely drag the entire eurozone into a recession.
Inflation in the eurozone has dropped from a peak of 10.6 percent last year to 5.3 percent in August. Food and energy inflation there is much more acute than in the United States, but there is little that the ECB can do to combat food and energy inflation, so I think the ECB may have made a mistake with its latest rate increase.
High rates are impacting several U.S. industries, including real estate. Last Tuesday, the Commerce Department reported that housing starts declined 11.3 percent in August, to an annual pace of 1.28 million, the lowest level since June 2020. And the National Association of Realtors reported that existing home sales declined 0.7 percent in August, to an annual pace of 4.04 million, the fifth consecutive monthly decline.
There is now only a 3.3 months’ supply of homes for sale. Existing home sales are low because most homeowners do not want to give up their low fixed mortgages. Overall, there seems to be no doubt that, due to high mortgage rates and tight inventories, existing home sales will continue to suffer.
