by Ralph Cole, CFA
Director Equity Strategy and Portfolio Management
Economic statistics are inherently backward looking while interest rate actions by the Federal Reserve Bank (the Fed) generally have a six to 12-month lag effect. The Fed is raising interest rates to slow the economy, which in turn should bring down inflation. This has typically been the relationship and the order of events, and we believe that will be the case this time around. The fine line central bankers walk is slowing the economy and inflation without breaking the economy and leading to a recession. They understand that they are looking at past statistics, while the economy has not yet felt the full brunt of their rate hikes.
The Economy is Slowing
One of the better and more timely economic indicators is the manufacturing index from the Institute of Supply Management (ISM). This report is based on survey responses from purchasing and supply executives from around the country. The ISM index fell to 50.9 in September, its lowest level in 2 years. Anything below 50 is seen as contraction, and historically, anything below 47 has signaled recession. As you can see below, the indicator is trending down, as the Fed wants, but is now starting to get into a more dangerous zone.
Source: Refinitiv
As part of that survey, the ISM also asks purchasing managers about the prices they are paying for products. The data indicates that the real supply chain bottlenecks are starting to loosen up, and prices are coming down. Yet another good sign for the Fed.
Housing Prices
Housing is one industry where everyone can see the relationship between higher interest rates and prices. As interest rates were cut to zero during the pandemic, and people’s housing desires changed, home prices soared. As you can see below, housing prices have already peaked and are starting to fall but remain higher than one year ago.
Source: Refinitiv
The Fed began hiking interest rates in March of 2022 by only 25 basis points - the immediate effect on housing and housing prices was negligible. Since then, the Fed has embarked on the steepest tightening cycle in 40 years, and it is starting to bite. The cost of housing has been one of the fastest growing parts of inflation, so with home prices and thus rental costs coming down, this can be taken as another sign that the Fed’s rate hikes are starting to have their intended effect.
Takeaways for the Week
There is a lag effect between when the Fed hikes rates, and the slowing of the U.S. economy
The economy is already starting to slow from manufacturing to housing, and we haven’t felt the overall impact of this tightening cycle