Is the Fed finally going to hit the pause button?

May 31, 2023

The U.S. central bank’s Federal Open Markets Committee meets June 13-14, and the central bank’s next move is front and center on the minds of investors. After rate increases at 10 consecutive FOMC meetings, is the Federal Reserve finally going to pause its relentless series of aggressive rate hikes? Or will the Fed’s governors conclude that the U.S. economy is still managing to power through the Fed’s open war on inflation?

On May 3, the Federal Reserve Bank boosted the federal funds rate by an additional 25 basis points, to a range of 5% to 5.25%, and signaled it may not increase interest rates when it meets again in mid-June. However, in his public remarks, Fed Chairman Jerome Powell was non-committal about future rate hikes. “A decision on a pause was not made today,” he said in response to a question from a New York Times reporter.

Source: Federal Reserve via Federal Reserve Bank of St. Louis

So when will a decision to be made? Powell indicated that he’s watching a number of factors and data points, including the labor market, inflation and the trajectory of the economy. There’s also the specter of a banking crisis that led to three of the four largest banking failures in U.S. history.

“We are seeing the effects of our policy tightening on demand in the most interest rate–sensitive sectors of the economy, particularly housing and investment,” Powell said in his prepared remarks. “It will take time, however, for the full effects of monetary restraint to be realized, especially on inflation.”

Investors closely watch the Fed because its moves reverberate through markets. When the central bank slashed rates to zero at the beginning of the pandemic, an asset bubble quickly inflated. And now that the Fed has been aggressively raising rates, values of the most speculative assets have come back to earth. The Real Asset Investor helps you navigate turbulent times and defend your wealth from inflation and taxes through a roster of high-quality investment opportunities. The ATM Fund routinely generates double-digit cash-on-cash returns, along with attractive tax benefits. We’re also building a portfolio of car washes in promising markets throughout the United States. And our self-storage properties generate returns and provide an inflation hedge by being able to adjust rents on a month-to-month basis.

Since Powell mentioned housing, it’s worth noting that the residential real estate market has cooled markedly since the pandemic boom. The 30-year fixed-rate mortgage averaged 6.39% as of May 18, according to Freddie Mac. That’s up from 5.25% a year earlier, and more than double the rock-bottom 3% seen in May 2021. The spike in mortgage rates has caused a dramatic slowdown in home sales – existing home sales in April 2023 were off 23.2% from April 2022, the National Association of Realtors reported. And the median sales price fell 1.7%, the largest decline in a decade.

While those dreary numbers conjure memories of the housing crash during the Great Recession, things are very different this time around. In one important distinction, almost no one is in danger of losing their home. “Distressed and forced property sales are virtually nonexistent,” said Lawrence Yun, the National Association of Realtors’ chief economist.

What’s more, home values in most parts of the U.S. have barely fallen from their recent record highs, meaning that most American homeowners are sitting atop hefty amounts of home equity.

Still-high home values and a still-strong labor market are buoying consumer spending. The Bureau of Labor Statistics’ April jobs report, delivered a couple days after Powell’s remarks, showed that the Fed still has its work cut out. Non-farm payrolls rose by 253,000, an unexpectedly strong reading. Meanwhile, the U.S. unemployment rate was just 3.4%, the lowest since 1969.

A strong job market has helped drive some impressive results in corporate earnings of late. For instance, Walmart reported May 18 that same-store sales were up 7.4% for the quarter ending April 30, well above the 5.3% analysts had expected. “That was about as impressive as a quarter that Walmart could have,” David Wagner, a portfolio manager at Aptus Capital Advisors, told Reuters.

Other corporate earnings reports showed an economy that has remained remarkably resilient despite the Fed’s hawkish policies. For instance, American Airlines’ earnings were up 37% in the first quarter. Hotel operator Marriott, for its part, said revenue per available room jumped 34% in the first quarter. Procter & Gamble, the consumer goods conglomerate, was another consumer bellwether to report better-than-expected first-quarter earnings.

True, every consumer brand continues to struggle with stubbornly high inflation, along with consumers’ concerns that the next recession lurks just around the corner. But the strong results from the job market, and from such companies as Walmart, American Airlines, Marriott and P&G, creates a conundrum for the Fed. Consumer spending drives more than two-thirds of U.S. economic output. Consumers have proven that they’re willing to spend. And if consumers are still spending, the Fed’s inflation-fighting task grows harder.

Inflation

The Fed’s rate hikes have managed to slow inflation from a peak of 9.1% in June 2022 to the most recent reading of 4.9% in April 2023. Some economists say that’s all the reason the Fed needed to pause interest rate hikes before its May meeting.

Critics of the central bank argue that the inflation crisis is a problem of the Fed’s own making. The Fed slashed rates to zero during the pandemic, then held them there as Powell dismissed rising prices as “transitory.”

Now that the Fed has entered the battle in earnest, it remains only halfway to its goal of 2% inflation. “My colleagues and I understand the hardship that high inflation is causing, and we remain strongly committed to bringing inflation back down to our 2% goal,” Powell said in May. For the U.S. economy, and for investors, slashing an additional 2.9 percentage points off the consumer price index could be grueling – and the battle is sure to create collateral damage, as it takes a toll in lost jobs, shrinking corporate profits and dwindling asset values.

For investors, these are uncertain times. The Real Asset Investor offers a variety of opportunities to help you sleep well at night. By investing directly with the people who will manage your capital versus investing in bonds or mutual funds, you get closer to your investment giving you greater control over your capital.