Fed Slows Pace of Rate Hikes as Inflation Shows Further Signs of Cooling

(The Fannie Mae Economic & Housing Weekly Note will not be published the last two weeks of December 2022. We expect to resume on January 6, 2023.)

Key Takeaways:

• At its December 13-14 meeting, the Federal Open Market Committee (FOMC) voted unanimously to raise the federal funds rate by 50 basis points to a target range of 4.25-4.75 percent, a downshift from the previous four 75-basis point hikes but still sufficient to bring the policy rate to its highest level since 2007. The FOMC statement noted that ongoing rate increases are likely, and the newly released Summary of Economic Projections (SEP) showed the median federal funds rate peaking at 5.1 percent in 2023, half a percentage point higher than the September SEP. The December SEP also showed a higher expected inflation path and a lower growth path in 2023 and 2024, when compared to September.
• The Consumer Price Index (CPI) increased 0.1 percent in November, a deceleration of three-tenths from October, according to the Bureau of Labor Statistics. On an annual basis, prices were up 7.1 percent, a sharp six-tenths deceleration from October. Food prices continued to run relatively hot, increasing 0.5 percent over the month, though this does represent a modest slowdown from the two months prior. Energy prices fell 1.6 percent as retail gasoline prices were down 2.0 percent and natural gas service fell 3.5 percent. Excluding food and energy, core prices rose 0.2 percent over the month and 6.0 percent over the year, decelerations of one-tenth and three-tenths, respectively. Core goods prices declined 0.5 percent primarily due to a 2.9 percent drop in used auto prices. Core services prices rose 0.4 percent, more than October’s measure, due primarily to rent rising 0.8 percent and owners’ equivalent rent increasing 0.7 percent.
• Retail sales and food services declined 0.6 percent in November, giving back some of the 1.3 percent gain in October, according to the Census Bureau. Part of the weakness was due to a 2.6 percent decline in sales at automobile dealers due to ongoing supply chain issues and a 0.1 percent pullback in sales at gas stations due to lower prices. However, core retail sales, which exclude food services, autos, building supplies, and gas stations, were still down 0.2 percent and were revised modestly lower in October. Restaurant and bar sales, which rose 0.9 percent, continued a streak of outperforming broader retail sales.
• Industrial production, a gauge of output in the manufacturing, utility, and manufacturing sectors, declined 0.2 percent in November, according to the Federal Reserve Board. Manufacturing output dropped 0.6 percent to reach its lowest level since August. Mining output was down 0.7 percent, while utilities output, which is largely dependent on the weather, rose 3.6 percent.
• The National Federation of Independent Business (NFIB) Optimism Index increased 0.6 points in November to 91.9. Sales conditions have improved modestly as, on net, negative 8 percent of firms expect real sales to be higher in the next six months, an increase of 5 percentage points and the highest level since February, and negative 22 percent of firms are reporting higher earnings this quarter, an improvement of 8 percentage points. Plans to raise average selling prices were flat at 34 percent of firms on net, while those planning to raise worker compensation declined 4 points on net to 28 percent. Inflation continues to rank as the single most important problem small businesses are facing, with 32 percent of smaller firms reporting it as such, though this does represent a 1 percentage point decline from October.

Forecast Impact:

Inflation slowed considerably for the second consecutive month in November. Encouragingly, whereas inflationary pressures were broad-based in the summer, current pressures are more concentrated in a few categories. These include food, which is frequently volatile and not necessarily indicative of underlying inflationary trends, and core services. The latter includes shelter, which, as we have discussed previously, lags current market conditions by a little over a year and we believe will show signs of slowing in mid-2023. That leaves the focus on core services less shelter. Given continued above-trend wage growth, and low productivity growth, this component remains inconsistent with the Fed’s target of 2-percent inflation and is thus likely to be the most important determinant of the Fed’s policy stance moving forward. Historically, downward wage growth movement is sticky, so we may not see concrete evidence of slowing wage growth for quite some time. Therefore, we believe there is a risk of a “higher for longer” rate stance from the Fed than financial markets are currently pricing, which is supported by their new SEP and statement from Chairman Powell.

Economic conditions weakened in November as retail sales pulled back after a very strong October that was likely boosted by one-time stimulus checks in California. While personal consumption growth is still on track for a strong fourth quarter, the implied slowdown in November from the retail sales report is consistent with our forecast for a significant slowdown in consumption growth next year coinciding with a recession. The first decline in manufacturing activity since June is also consistent with our expectation of economic weakening resulting in a recession next year, as manufacturing tends to be a particularly cyclical component of the economy.

Nathaniel Drake
Economic and Strategic Research Group
December 16, 2022

Opinions, analyses, estimates, forecasts, and other views of Fannie Mae's Economic and Strategic Research (ESR) Group included in these materials should not be construed as indicating Fannie Mae's business prospects or expected results, are based on a number of assumptions, and are subject to change without notice. How this information affects Fannie Mae will depend on many factors. Although the ESR group bases its opinions, analyses, estimates, forecasts, and other views on information it considers reliable, it does not guarantee that the information provided in these materials is accurate, current, or suitable for any particular purpose. Changes in the assumptions or the information underlying these views could produce materially different results. The analyses, opinions, estimates, forecasts, and other views published by the ESR group represent the views of that group as of the date indicated and do not necessarily represent the views of Fannie Mae or its management.