Fed Hikes Rates by 75 Basis Points to Combat Persistently High Inflation
- At its June 15-16 meeting, the Federal Open Market Committee (FOMC) voted to raise the target rate for the federal funds rate by 75 basis points to a range of 1.5-1.75 percent, the largest hike since 1994. In addition, the committee’s median projection for the federal funds rate by the end of 2022 is now 3.4 percent, up from 1.9 percent in March, and its expectations for GDP this year were revised down to 1.7 percent from 2.8 percent in March. In his press conference, Chairman Powell stated he does not expect 75 basis point hikes to be common, but either a 50 or 75 basis point hike will likely be appropriate in July as the committee was likely looking to front-load rate hikes to cool inflation.
- Retail sales and food declined 0.3 percent in May and were revised downward by two-tenths in April to a 0.7 percent gain, according to the Census Bureau. Motor vehicle and parts dealer sales were down 3.5 percent amid ongoing supply chain issues. Furniture store sales fell 0.9 percent and electronics and appliance store sales declined 1.3 percent. Due to higher prices, gasoline store sales increased 4.0 percent. Restaurant sales were among the few bright spots, rising 0.7 percent for their fourth consecutive monthly gain. Core retail sales (excluding food services, autos, building supplies, and gas stations) were flat in May, though April's figure was revised downward from a gain of 1.0 percent to a gain of 0.5 percent.
- The Producer Price Index (PPI) for final demand of goods are services increased 0.8 percent in May, an acceleration of four-tenths from April, and was up 10.8 percent over the year, a deceleration of one-tenth, according to the Bureau of Labor Statistics. Final demand for energy increased 5.0 percent. Final demand for services increased 0.4 percent. Core PPI (less food, energy, and trade services) increased 0.5 percent over the month, an acceleration of one-tenth, and 6.8 percent annually, the same as in April.
- The National Federation of Independent Business (NFIB) Small Business Optimism ticked down one-tenth to 93.1 in May, its lowest level since April 2020. A net 26 percent of firms plan to increase employment, up 6 percentage points from April, while 51 percent of firms say they have positions they are unable to fill, an increase of 4 percentage points and a series record. On net, negative 54 percent of firms expect the economy to improve, a series record low. 72 percent of firms are raising average selling prices, a 2-percentage point increase after a brief dip in April, and 49 percent of firms reported raising worker compensation over the past three months, an increase of 3 percentage points. 28 percent of firms reported inflation as their largest problem, a decline of 4 percentage points, but the number of firms rating the cost of labor increased by 4 percentage points, reaching 12 percent.
- Housing starts declined 14.4 percent in May to a seasonally adjusted annualized rate (SAAR) of 1.5 million, though April’s figure was revised upward by about 6 percent, according to the Census Bureau. Single-family starts were down 9.2 percent to a SAAR of 1.1 million, while often-volatile multifamily starts fell 23.7 percent to a SAAR of 498,000. Single-family permits declined 5.5 percent to a SAAR of 1.1 million, while multifamily permits slid 9.4 percent to a SAAR of 647,000.
- The National Association of Home Builders/Wells Fargo Housing Market Index declined 2 points to 67 in June, 23 points below its November 2020 peak and its sixth consecutive monthly decline. The index for single-family sales in the present was down 1 point to 77, while the index for sales in the next six months declined 3 points to 61. Foot traffic of prospective buyers declined 5 points to 48, its lowest level since July 2019, after excluding the COVID-related shock.
The Fed's 75-basis point rate hike was higher than our official forecast, though the market largely deemed it inevitable after reports that the committee was considering such a move were released on Monday. We believe Chair Powell’s comments regarding front-loading future rate hikes increase the probability of another 75-basis point hike in July before slowing through the end of the year. Still, with near-term inflation risks to the upside, we think rates may need to go even higher than the median expectation of 3.4 percent at year end in the Fed’s newly released Summary of Economic Projections.
This week's PPI and NFIB results failed to provide any evidence of slowing price pressures, and several price-related components of the NFIB survey actually moved up in May after small declines in April. Growth may be slowing, however, as retail sales came in below expectations this month and were revised downward for April. This reflects slower real consumption growth due to increasing prices, so we will likely be downgrading our Q2 consumption forecast. One positive, however, is that restaurant sales outperformed other retail sales, suggesting a continued pivot toward services that may alleviate price pressures in certain durable goods categories. Taken as a whole, though, this report suggests to us that higher prices (and perhaps higher interest rates in the case of big-ticket items) are beginning to cut into real consumption, which, if it continues, we believe would be an ominous sign for economic growth.
In housing, after considering the April revision, second quarter construction is trending slightly above our expectations. With permits at a seasonally adjusted annualized rate of 1.70 million in May, down 7.0 percent from the upwardly revised April figure, we believe construction is clearly slowing but not free-falling. One encouraging sign from this report is the 9.1 percent jump in completions, though a significant portion of the completions came from buildings with 5-plus units. Still, this could be a sign that construction backlogs may finally be easing. Though builder confidence was down again this month, we think this report is consistent with our view that, while residential construction will continue to slow, the near-term pace may demonstrate greater resilience, even in the face of rising mortgage rates.
Economic and Strategic Research Group
June 16, 2022
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