Recession Fears Escalate As Fed Holds Firm On Rate Hikes
As anticipated, The Fed raised short-term interest rates by .50 bp on Wednesday. The initial market reaction was neutral, but sentiments changed once the markets digested the Fed’s resolve to fight inflation on Thursday. Additionally, the Fed emphasized its projection that short-term interest rates may go higher than expected due to the very tight labor market. The markets are concerned because the economy seems to be weakening. Major corporations have announced job cuts, credit card balances have risen, and U.S. retail and manufacturing spending has slowed. Market experts are attempting to reconcile how far the Fed is willing to see real estate and equity markets decline, rather than not do enough to squash inflation. The most vulnerable parts of society are hurt by inflation the most. Powell has referenced the need for “pain”(financial pain or the decline in asset prices) several times over the last many months as the unfortunate result of taming inflation.
Across the pond, European central bankers were also very hawkish about where interest rates will need to go to quell inflation. U.S. Treasury yields remain very volatile as expectations of tighter financial conditions loom. Speaking of bonds, the inverted yield curve is an excellent indicator of recession probability. How steeply the yield curve dips signifies to the bond market that a recession is likely. However, a counterargument can be made for higher interest rates as liquidity is taken out of the system. It seems logical investors will demand more yield for each unit of risk. Interest rates along the yield curve should move up. Also, onshoring of industrial production and pivoting from just-in-time inventory to certainty-of-inventory, employee demands for higher wages, as well as a low level of “total employed” are inflationary. In the end, the best financial advice this year has been to “not fight the Fed.” The Fed wants positive real rates across the whole yield curve and fighting the Fed is usually not wise. While no one can predict the future, we are in the midst of a paradigm shift in interest rates. The results of this shift will be felt in the coming year.
Interest rates have dipped slightly, and that has led to a small increase in activity. Winter has always been a historically slow time of year, but the jumbo hikes the Fed has undertaken have certainly slowed the market. With inflation coming down, the hope is interest rates will normalize and thereby help the real estate market. As 2023 approaches, lenders will have new funding targets, which should help as banks compete for new business.
