What Will the Fed Do?

NAHB Chief Economist Robert Dietz provided the following economic overview in his bi-weekly newsletter Eye on the Economy.

The bond market is anticipating the Federal Reserve will not increase rates at the conclusion of its monetary policy meeting next Wednesday. However, there is a growing possibility of a final rate hike in November. The NAHB forecast sees one additional interest rate increase occurring either at the September meeting or the November meeting.

This decision will largely be determined by incoming inflation data. For August, the Consumer Price Index (CPI) came in hotter than expected, posting a 3.7% year-over-year gain. However, the core CPI, which is of greater interest for monetary policy, was up 4.3% from a year ago. This is an improvement from the July reading of 4.7%. Core CPI peaked at 6.6% in September 2022. Inflation increased in August due to a 10.6% surge for gas prices.

Shelter inflation was 7.3% higher than a year ago, because of a lack of housing and elevated construction costs. However, the CPI records shelter inflation with a multi-month data lag. Real-time data show rent growth leveling off, and additional downward pressure will be exerted on rents as additional apartment supply enter the market.

If shelter inflation had been flat in August, the CPI would be well below the Fed’s 2% target. This is a reminder that home building would have a significant anti-inflationary impact.

The bond market reacted to the August CPI data with a slight increase for the 10-year Treasury rate, rising to above 4.25%. This rate is still lower than the peak set in late August (4.35%). Nonetheless, these financial conditions will continue to support 7-plus percent mortgage rates, with this trend continuing until the Fed provides certainty that it is finished tightening.

What follows? A period of higher rates until mid-2024, when the Fed will likely begin reducing nominal rates as inflation data approach the central bank’s target ranges.

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