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Weekly Update 9/23/2022: Fed Delivers Another 75 Basis Point Rate Hike

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Domestic Economic News

A gauge of US homebuilder sentiment declined for a ninth straight month in September as mortgage rates continued to climb, further accelerating the housing-market cool-down. The National Association of Home Buyers/Wells Fargo gauge decreased by three points to 46, figures showed Monday. Homebuilder sentiment has fallen every month this year, the longest stretch of declines in data back to 1985. The Federal Reserve is expected to raise interest rates by another 75 basis points this week as it tries to tame stubbornly high inflation, and housing is particularly sensitive to tighter policy. Mortgage rates topped 6% last week for the first time since the housing-market downturn in 2008. The report’s measures of current and future sales of single-family homes both fell further in September to the weakest levels since May 2020. A metric of prospective buyer traffic also reached the lowest level since then. “The housing recession shows no signs of abating as builders continue to grapple with elevated construction costs and an aggressive monetary policy from the Federal Reserve,” NAHB Chief Economist Robert Dietz said in a statement. More than half of builders surveyed are using incentives like mortgage rate buydowns, free amenities and price reductions to boost sales, Dietz said. The West posted the largest drop in sentiment, followed by the South. Sentiment in the Midwest and Northeast remained unchanged.

In separate housing news, new US home construction rose unexpectedly in August, fueled by a pickup in multifamily dwellings, though a drop in building permits underscored how higher mortgage rates are weighing on demand. Residential starts increased 12.2% last month to a 1.58 million annualized rate, after a downwardly revised 1.4 million pace in July, according to government data released Tuesday. The median forecast called for a 1.45 million pace. Applications to build, a proxy for future construction, declined to an annualized 1.52 million units, the fewest since June 2020.

Applications for US unemployment insurance rose for the first time in six weeks but remained historically low, suggesting demand for workers remains healthy despite an increasingly uncertain economic outlook. Initial unemployment claims increased by 5,000 to 213,000 in the week ended Sept. 17, after a downward revision in the prior week, Labor Department data showed Thursday. The median estimate in a Bloomberg survey of economists called for 217,000 new applications. The four-week moving average, which smooths out volatility from week to week, fell to 216,750. Continuing claims dropped to 1.38 million in the week ended Sept. 10. Jobless claims have generally been dropping as employers try to fill millions of open positions while retaining the workers they already have. However, hiring is expected to weaken as the Federal Reserve continues to raise interest rates, with employment being a key sacrifice in the central bank’s effort to bring inflation down. Chair Jerome Powell, in a press conference after the Fed raised rates by another 75 basis points on Wednesday, said that there isn’t a “painless way” to restore price stability, and that a softening labor market is one of the prices to pay. Policy makers now see unemployment rising to 4.4% by the end of next year and the same at the end of 2024 -- up from 3.9% and 4.1%, respectively, in the June projections.

Interest Rate Insight and the Fed

Investors appear to have been breathing just a little easier about US inflation ahead of the Federal Reserve decision this week. Money has been flowing in recent weeks out of some of the biggest exchange-traded funds that are linked to Treasury-Inflation Protected Securities, instruments that provide a measure of insurance against a ballooning CPI. Meanwhile breakeven rates on TIPS, a proxy for where the market sees the CPI rate going, have also been pulling back. That comes even after the most recent CPI data came in hotter than expected, because those figures have helped spur bets on much higher interest rates aimed at nipping such advances in the bud. Expectations for where the benchmark fed funds rate could ultimately go in early 2023 have at times risen to more than 4.5%.

Federal Reserve officials raised interest rates by 75 basis points for the third consecutive time and forecast they would reach 4.6% in 2023, stepping up their fight to curb inflation that’s persisted near the highest levels since the 1980s. In a statement Wednesday following a two-day meeting in Washington, the Federal Open Market Committee repeated that it “is highly attentive to inflation risks.” The central bank also reiterated it “anticipates that ongoing increases in the target range will be appropriate,” and “is strongly committed to returning inflation to its 2% objective.” The decision, which was unanimous, takes the target range for the benchmark federal funds rate to 3% to 3.25% -- the highest level since before the 2008 financial crisis, and up from near zero at the start of this year. Officials expect the benchmark rate to rise to 4.4% by year end and 4.6% during 2023, according to the median estimate in updated quarterly projections published alongside the statement. That indicates a fourth-straight 75 basis-point hike could be on the table for the next gathering in November, about a week before the midterm elections. Further ahead, rates were seen stepping down to 3.9% in 2024 and 2.9% in 2025. The projections, which showed a steeper rate path than officials laid out in June, underscore the Fed’s resolve to cool inflation despite the risk that surging borrowing costs could tip the US into recession. Before the release, traders expected rates to reach 4.5% in early 2023 before falling about a half point by the end of the year.

Powell and his colleagues, slammed for a slow initial response to escalating price pressures, have pivoted aggressively to catch up and are now delivering the most aggressive policy tightening since the Fed under Paul Volcker four decades ago. The updated forecasts also showed unemployment rising to 4.4% by the end of next year and the same at the end of 2024 -- up from 3.9% and 4.1%, respectively, in the June projections. Estimates for economic growth in 2023 were marked down to 1.2% and 1.7% in 2024, reflecting a bigger impact from tighter monetary policy. It’s a tricky balancing act – the fed has a dual mandate in terms of controlling inflation and maintain full employment. They have aggressively raised rates and are talking tough these days – but at some point they will ease their foot off the brake pedal so they do not put us in a more severe recession than is currently anticipated.

We should note a significant contributor to inflation has been the supply chain issues we have been experiencing. We had some positive news this week as the backlog at ports that contributed to supply-chain disruptions and a surge in consumer prices is slowing. Changes in container flows precede GDP changes, and the current trend is lower. Slower growth and declining demand will at some point bring less inflation. Port of Long Beach Executive Director Mario Cordero expects the pandemic-era surge in US consumer demand that snarled supply chains to start to cool, with evidence of a deceleration beginning to show in weaker inbound container arrivals. Many commodity prices are also falling. Better supply flows and slower demand sets up a potential for a rate hike pause at some point from the fed.

Impactful International News

In a positive international headline this week, Canada’s inflation rate eased for a second month in August on lower gasoline prices, a welcome development that may give the Bank of Canada confidence its interest rate hikes are working. The consumer price index rose 7% from a year ago, down from 7.6% in July and a four-decade high of 8.1% in June, Statistics Canada reported on Tuesday. Economists expected a reading of 7.3%. During the month of August, prices fell 0.3%, the largest monthly decline since the early months of the Covid-19 pandemic. So-called core inflation -- which excludes more volatile prices to generate a better gauge of underlying pressures -- also decelerated. The average of the central bank’s three key measures dropped to 5.23% from a revised 5.43% in July, a record high. “That’s moving in the right direction, because certainly for the Bank of Canada, its focus is almost entirely on those core measures,” Sal Guatieri, a senior economist at Bank of Montreal, said on BNN Bloomberg Television. “I think it’s still far too early for the Bank of Canada to let down its guard, though.” The loonie fell about 0.4% to trade at C$1.3337 per US dollar as of 9:42 a.m. Toronto time. Bonds rallied, pushing the yield on benchmark two-year debt down about 9 basis points from its pre-release level to 3.763%. While Augusts inflation numbers aren’t likely to derail bets on further rate increases in coming weeks, the deceleration suggests the Bank of Canada’s “front-loading” of hikes is cooling the economy and slowing demand enough to wrangle price pressures down quickly -- without requiring rates to increase too far into restrictive territory. Two weeks ago, policy makers led by Governor Tiff Macklem raised the policy interest rate by another 75 basis points to 3.25% in one of the bank’s most aggressive hiking cycles ever. The rate had been holding at an emergency pandemic low of 0.25% until March.

In some additional positive news on the international front from the world’s second largest economy, the Chinese megacity of Chengdu exited its lockdown on Monday, with 21 million people allowed to leave their homes and resume most aspects of normal life for the first time since Sept. 1, provided they’re tested regularly for Covid-19. Residents will need to be tested at least once a week for the virus, with a negative result from within the previous 72 hours required to enter most venues and take public transportation, according to a statement from the local government. The capital of the southwestern Sichuan province, Chengdu is the biggest city to have been shuttered as part of the country’s Covid Zero strategy since Shanghai’s bruising two-month lockdown earlier this year. The shorter duration of Chengdu’s stay-at-home order -- just over two weeks -- removes a source of potential instability for President Xi Jinping, who is expected to proclaim the policy a success at the Communist Party congress in mid-October, despite its high economic and societal costs. Officials in Chengdu locked down sooner in their outbreak than authorities in Shanghai. That appears to have largely avoided the food and medicine shortages, manufacturing halts and supply-chain snarls that spurred protests and unrest in China’s most metropolitan city, dragging on growth in the world’s second-largest economy. Chengdu’s lockdown has been more in line with Shenzhen’s earlier in the year, with movement restrictions in the technology hub eased after about a week, as cases ebbed.

High-frequency indicators for China show government policy boosting construction even as it hamstrings the consumer-side of the economy. Higher steel output and falling rebar inventories show the positive impact of infrastructure investment on the construction industry. On the other hand, Covid Zero continues to keep shoppers home despite falling virus cases. Here are some of the indicators: Daily steel output edged up about 3.3% in the first 10 days in September compared with the period at the end of August; Rebar inventories continued to decline. Stockpiles have fallen steadily since mid-June, with infrastructure investment helping to fuel building activity; Daily reported Covid-19 cases fell to 905 in the week through Sept. 16, down 42% from the last week of August; Subway ridership edged up from first week of September, but was still 8% below the end-August level and 26% below pre-pandemic numbers; The housing market remained weak. Home sales in major cities were basically unchanged in the first nine days of September, compared with the level at the end of August. This was 49% below the average of 2019’s level; Car sales were 23% below the pre-pandemic level in the week ended Sept. 2, as the boost from June’s cut to the purchase tax faded. We expect a slight improvement in coming weeks, but not enough to lift September’s full-month sales above the August level. Stay Tuned!

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