Housing hampers a Fed pivot in September
It makes sense to prepare for such an outcome. Slowing economic growth could conspire with cheaper commodities and bloated inventories to help calm inflation in the months ahead. By then, the Fed is also expected to have its key rate at a level it considers restrictive, which will put further downward pressure on prices.
This would allow the central bank to slow its pace of raising interest rates or even signal a pause in future meetings. Although the economy is cooling rapidly, Powell might even be able to save the labor market with such a move. Still, the stars must align for a Fed “pivot” to materialize so soon:
• The United States is expected to post three months of decline in core inflation, measured month-over-month.
• The pace of house price appreciation needs to slow (in market price indicators, not in the inflation index).
• Energy prices should remain contained.
As Powell said last month, he wants to see a “streak” of falling inflation reports before considering a change in strategy. A widely followed Cleveland Fed nowcast suggests the consumer price index, excluding volatile food and energy prices, fell month-over-month in June and could do it again in July. A third cut in August would give the Fed a good excuse to change its story. Of course, the Fed will only have two reports in hand for its preferred measure, the core PCE, but it can be assumed that it will follow a similar path to that of the CPI.
The big issue is housing, one of the more idiosyncratic components of the inflation basket. Housing flows into inflation through rents and a category called owners’ equivalent rent, a measure based on polled estimates of what people think their homes would rent. As such, announced housing inflation lags market prices by several months. Due to mechanics alone, housing will likely continue to exert upward pressure on the index well into 2023, and there may come a time in the not-too-distant future when policymakers may decide to look beyond that. of the housing component of the index.
But that can’t happen until market prices start to drop significantly. There is no doubt that trading is slowing down quickly, and that should affect prices soon enough. But in part because of near-historic inventory shortages, prices have remained resilient so far, giving the Fed little cover to look through to housing.
Finally, energy prices must remain under control for the Fed to soften its stance in September. Policymakers don’t typically calibrate policy based on volatility in food and energy prices, but the sharp moves in the past six months have influenced how consumers view inflation. Powell thinks inflation expectations can be a self-fulfilling prophecy and thinks it’s essential to keep them anchored. It’s hard to imagine that the Fed would back down if oil prices exploded above $120 a barrel again. (West Texas Intermediate crude futures dipped below $100 on Tuesday, a big boost for the pivot thesis if it can hold.)
So why is the Fed even waiting? Certainly, some investors would like the central bank to pivot now in response to signs of weakening real consumer demand and a slowing manufacturing sector. However, this is very unlikely to happen. Waves of inflation tend to come in batches, and if the Fed stops tightening below 2.5% — its idea of the neutral fed funds rate which is neither stimulative nor restrictive — it could be considered as a historic policy failure if prices spike again or fail to return to the Fed’s 2% target.
But the situation will be different in a few months. The fall of the S&P 500 index will have lasted 10 months in October, corresponding to the average duration of American bear markets. With all the bizarre cross-currents in today’s economy, even the most avowed stock market bears need to recognize that by then, there is a real possibility – albeit a very uncertain one – that everything could change in no time. time.
More other writers at Bloomberg Opinion:
• Slowdown story faces ugly ending for stocks: John Authers
• Biden has some lessons for Newsom on inflation: Karl Smith
• Soaring gas prices aren’t as painful as they look: Robert Burgess
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Jonathan Levin has worked as a Bloomberg reporter in Latin America and the United States, covering finance, markets, and mergers and acquisitions. Most recently, he served as the company’s Miami office manager. He holds the CFA charter.
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