Weekly Update 12/20/2024: Fed Executes “Hawkish Cut”
- Retail sales above expectations
- General Mils reports solid second quarter
- Pfizer provides upbeat guidance
- Accenture's earnings and guidance power shares higher
Housing data
A survey by the National Association of Homebuilders and Wells Fargo showed a gauge of sales in the next six months increased to 66 this month, the highest since April 2022. “While builders are expressing concerns that high interest rates, elevated construction costs and a lack of buildable lots continue to act as headwinds, they are also anticipating future regulatory relief in the aftermath of the election,” said NAHB Chairman Carl Harris, a custom home builder from Wichita, Kansas. “This is reflected in the fact that future sales expectations have increased to a nearly three-year high.” Construction firms have enticed customers with mortgage discounts and other incentives. Builders are hoping the Trump administration will remove construction regulatory hurdles that will also help boost sales.
That optimism was tempered by data on housing starts which fell to a four-month low. According to the Census Bureau, housing starts declined 1.8% to an annualized rate of 1.29 million, the slowest since July. The median forecast called for a 1.35 million annualized rate. The South saw a bold 18.3% advance thanks to rebuilding following two hurricanes which hit Florida in late September and October. Meanwhile, all other regions declined in activity with the Midwest down 28.2% and the West lower by nearly 12%. Building permits, which is a proxy for future construction, rose 6.1% to a 1.51 million annualized rate, reflecting some of the positiveness seen in the homebuilder survey. Nevertheless, the number of projects under construction fell 1.8%, the lowest level in more than three years.
Existing home sales rose to a 4.15 million pace in November according to data from the National Association of Realtors. That was above the median of 4.09 million in a survey of economists by Bloomberg. Though the most recent data is hopeful, the average 4 million annualized pace is just three-quarters of the pre-pandemic level. The main reason for this lethargy is because of a historic shortage of homes for sale. Owners, seeing mortgage rates shoot above 7% a few years ago, decided to stay put and not list their properties because moving would have resulted in higher monthly costs if they opted for a house in a similar price range. When the Federal Reserve drove its benchmark rate down to 0% in response to the pandemic, mortgage rates followed with many hovering around 3% for years until Covid-related supply chain issues and a resurgent consumer combined to jolt prices (and rates) higher. According to the Mortgage Bankers Association, mortgage rates are expected to stay above 6% for at least another two years. In addition to mortgage headwinds, affordability is providing a further challenge. The median sales prices of a previously owned home rose 4.7% to $406,000 from a year earlier. First-time buyers comprised 24% of purchases for the year, the lowest on record, further emphasizing the challenge to today’s families. Properties stayed on the market for 32 days on average, compared to 29 days in October.
Retail sales
According to the Census Bureau, retail sales rose 0.7% (versus a consensus estimate of +0.6%) in November kicking off the holiday season on a positive note. Excluding autos, sales climbed 0.2% for the second consecutive month. Control-group sales—which excludes cars, gas, food services and building materials—grew 0.4%, in line with consensus and rebounding from a 0.1% decline in the prior month. Seven of the report’s 13 categories increased including sales of motor vehicles and parts, sporting goods, electronics and non-store retailers (i.e., online purchasing). Clothing and restaurant spending were two categories which declined. The coming months will determine whether this above-consensus report was due to “buy-in-advance” behavior to avoid potential tariffs or whether the boost was truly due to a more confident consumer boosted by fundamentals such as job creation.
Fed Day
The Federal Open Market Committee (FOMC) met this week as scheduled and decided to lower its benchmark interest rate by 25 basis points (0.25%) to a range of 4.25%-4.50%. The cut was not unanimous with one governor, Cleveland Fed President Beth Hammack, voting to keep rates unchanged. The markets interpreted the move to be a “hawkish cut” meaning that though rates were moved lower, the accompanying language and post-meeting press conference made it clear that the Fed was shifting to pause mode. “Today was a closer call but we decided it was the right call,” Fed Chairman Jerome Powell said at a news conference after the meeting. “From here, it’s a new phase, and we’re going to be cautious about further cuts.”
The summary of economic projections showed that officials thought there would be fewer cuts in 2025 as evidenced in the widely-followed “dot plot”. By next December, the federal funds rate was expected to be right around 4.0% meaning that two more 25 basis point cuts were being priced in. That was down from the four cuts expected by the markets following September’s meeting when the last summary of economic projections was released. Before the pandemic, some Fed members speculated that the so-called neutral rate of interest, meaning the level which is neither restrictive nor stimulative, was below 3%. Because the economy has held up so well post-pandemic, the thinking has shifted that the neutral rate, which is unobservable, had gone up. If so, then the Fed does not need to implement as many rate cuts to fulfil its goals. In their projections, the Fed increased its core inflation forecast for 2025 to 2.5% from 2.2% in September and lowered their unemployment projection to 4.3% from 4.4%.
Thus, the Fed has basically pushed the timetable to reach its inflation target of 2% further back. In response to a reporter’s question about if the Fed was “close enough” to its inflation target, Powell responded, “We’re not going to settle for that.” This shows that the uncertainty of the incoming administration’s penchant for tariffs is going to affect how the Fed approaches monetary policy. Powell stated that some Fed officials had started incorporating potential new policies into their forecasts, but the exact timing and impact was still uncertain. Inflation fighting has been “slower than we’d hope” admitted Powell but “we’re still on track.” We have made the assertion numerous times in these newsletters that non-housing services inflation was “sticky” and taming price increases in this area would be an issue. Though goods inflation has shown sign of outright deflation, it moves in cycles, and, as time passes, the economy will eventually overlap low figures. The question is if the disinflationary trends in the service sector are enough to drive overall prices lower and keep the Fed from stopping its rate cut plan altogether. We will have much more to say about the direction the Fed is taking for 2025 and how it will affect markets in our quarterly commentary out next month so be sure to give it a read!
Personal income and spending
The Fed’s preferred measure of inflation is the personal consumption expenditure (PCE) index. While data from the consumer and producer price indices give economists a good handle on where the PCE will be, it is always good to have all the supporting data. Unfortunately, the Fed’s meeting concluded two days before the latest PCE info was released. The so-called core PCE, which excludes food and energy prices, rose 0.1% from October to November and 2.8% from a year earlier, according to the Bureau of Economic Analysis. This was the slowest monthly advance since May. That is good news from the perspective that it marks the first signs of renewed progress on fighting inflation which seemed to have stalled in recent months. It helps support the “soft landing” thesis which the Fed prefers—namely continued GDP growth (with third quarter annualized growth revised higher to 3.1% this week versus the previous reading of a 2.8% expansion) with muted price pressures and stable unemployment. The ongoing debate on Capitol Hill over the budget's continuing resolution impasse may put pressure on the employment factor in that equation. We will continue to monitor events, but, at the time of this writing, no negotiated settlement had been reached.
The main takeaway is that there was a broad-based deceleration in inflation. Core services prices, which excludes housing and energy, rose at the slowest pace since August. One- and three-month annualized core PCE inflation improved in November, slowing to 1.4% from 3.2% and to 2.5% from 2.8%, respectively. However, six-month annualized core inflation ticked up to 2.4% in November from 2.3% in October. Core goods prices, which excludes food and energy, actually fell for the first time in three months. Personal income rose 0.3% in November versus the month prior, while personal spending was up 0.4%. Both of those metrics were below the consensus estimate in a Bloomberg survey of economists.
Would receiving these figures have changed the Fed’s decision? Unlikely. As we mentioned, the Fed could already estimate the PCE figures by the time their scheduled meeting began on Tuesday morning. We know that Chairman Powell and the committee are unlikely to change course based upon just one month of data. But it is not too much of a stretch to assume that, knowing their preferred gauge was likely to soften, they had cover to reduce rates as they did, even if every member of the committee did not agree. Could these be the start of a sustained downward trend in PCE? Possibly. While financial services prices slowed as expected, past months’ equity market gains could provide a ‘wealth effect’ boost to spending once December’s figures are out in the later half of January. Recreational services—think gym club memberships, movie theaters and sports centers—usually get a boost around the holiday season which could also keep services prices propped up heading into the new year. Bottom line, the Fed had a justifiable cut to its benchmark, and they are equally valid to argue that a pause down the road is fair. It will depend upon the economic statistics which will be released in the weeks to come. Stay tuned.
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