Yet Wall Street investors have priced in only one more hike. Collectively, in fact, they expect the Fed to reverse course and actually cut rates by the end of this year. That optimism has helped drive stock prices up and bond yields down, easing credit and pushing in the opposite direction that the Fed would prefer.
The divide between the Fed and financial markets is important because rate hikes need to work through markets to affect the economy. The Fed directly controls its key short-term rate. But it has only indirect control over borrowing rates that people and businesses actually pay — for mortgages, corporate bonds, auto loans and many others.
The consequences can be seen in housing. The average fixed rate on a 30-year mortgage soared after the Fed first began hiking rates. Eventually, it topped 7 per cent, more than twice where it had stood before the hiking began.
Yet since the fall, the average mortgage rate has eased to 6.13 per cent, the lowest level since September. And while home sales fell further in December, a measure of signed contracts to buy homes actually rose. That suggested that lower rates might be drawing some home buyers back to the market.
Over the past several months, the Fed’s officials have reduced the size of their rate increases, from four unusually large three-quarter-point hikes in a row last year to a half-point increase in December to Wednesday’s quarter-point hike.
The more gradual pace is intended to help the Fed navigate what will be a high-risk series of decisions this year. The slowdown in inflation suggests that its rate hikes have started to achieve their goal. But measures of inflation are still far above the central bank’s 2 per cent target. The risk is that with some sectors of the economy weakening, ever-higher borrowing costs could tip the economy into a recession later this year.
Retail sales, for example, have fallen for two straight months, suggesting that consumers are becoming more cautious about spending. Manufacturing output has fallen for two months. On the other hand, the nation’s job market – the most important pillar of the economy – remains strong, with the unemployment rate at a 53-year low at 3.5 per cent.
Over the past year, with businesses sharply raising pay to try to attract and keep enough workers, Powell has expressed concern that wage growth in the labour-intensive service sector would keep inflation too high. Businesses typically pass their increased labour costs on to their customers by charging higher prices, thereby perpetuating inflation pressures.
But recent gauges show that wage growth is slowing. And in December, overall inflation eased to 6.5 per cent in December from a year earlier, down from a four-decade peak of 9.1 per cent in June. The decline has been driven in part by cheaper gas, which has tumbled to US$3.50 a gallon, on average, nationwide, from US$5 in June.
Supply chain backups have also largely been cleared, leading to a drop in prices for manufactured goods. Used car prices, having skyrocketed in the pandemic amid an auto shortage, have now fallen for several months.
Other major central banks are also fighting high inflation with rate hikes. The European Central Bank is expected to raise its benchmark rate by a half-point when it meets Thursday. Inflation in Europe, though slowing, remains high, at 8.5% in January compared with a year earlier. Food and energy costs are fueling price spikes on the continent after Russia’s invasion of Ukraine has disrupted energy markets and are still affecting consumers’ utility bills.
The Bank of England is forecast to lift its rate at a meeting Thursday as well. Inflation has reached 10.5 per cent in the United Kingdom. The International Monetary Fund has forecast that the U.K. economy will likely enter recession this year. It expects the U.S. and the 20-nation euro zone to post modest growth.
- AP
