The latest decision from the two-day FOMC Meeting came as little surprise to financial markets anticipating little in the way of action on interest rates and broader policy. However, it does not mean the decision lacked importance. If anything, the contents of the FOMC Statement produced a sense that even the best laid plans go to waste. Although inflation “will” get back to the 2.00% targeted by the institution over the medium-term, the context of the decision nevertheless highlighted the more dovish leanings of the Federal Reserve.
With more questions than answers following the latest FOMC decision, the reaction in financial markets has been palpable. However, from an economic perspective, the Fed is just starting to see the impact of its December decision to raise interest rates. Between faltering housing fundamentals and potential labor headaches, the new US Administration will find it difficult to live up to the hype exhibited by financial markets over the last few weeks. Considering the backdrop, new highs in equity benchmarks may be a little premature relative to actual economic conditions.
Inflation Remains Worrisome
Although the headline inflation figures released late last month seemed to suggest that consumer prices were back on the upswing, helped in large part by resurgent energy prices and rising rent costs, the Fed’s perspective proved markedly different. According to the statement from the decision, the Fed believes that “market-based measures of inflation compensation remain low.” In simpler terms, the Fed is largely unimpressed by the momentum in consumer price gauges despite taking a more hawkish viewpoint with the belief that inflation will rise back towards the 2.00% target. Headline CPI did print at 2.10% during December, though the more closely watched core PCE inflation is currently at 1.70%.
Besides the fact that core inflation, which traditionally strips away the more volatile food and energy components, remains below the Fed’s target, other areas of the economy have been impacted by higher rates. While it may be viewed as still too early to tell whether higher rates are dissuading potential buyers, both existing home and new home sales figures for December missed expectations by a wide margin. Furthermore, rising pending home sales suggest that buyers may be having a change of heart as the outlook for mortgage rates indicates rising costs. It is easy to cheerlead the most recent S&P Case-Shiller home price index at a record high as proof of a stable housing market, but the figure is from November, before rates were last hiked.
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