Interest Rate Checkup: Will The Fed Tighten?

A: Inflation fearing people out there had a rough few days as some economic data came out showing a rise in prices beyond food and energy. Core consumer prices rose 0.3 percent in April, higher than expected and feeding inflation worries. This is why the stock markets took such a big hit the past 2 days because the data that came out will only strengthen the case for the Fed to raise the fed funds rate again at their June meeting.

Equity markets do NOT like inflation because that means the fed will be raising interest rates to slow down the economy by making borrowing costs more expensive and fixed assets more attractive for investments. On a side note, expect a stock market rally once we get clear word from the Fed that they will pause on their long interest rate hike campaign (16 consecutive 1/4 point rate hikes so far).

Lets take a quick look at some data/markets to see where we stand RIGHT NOW:

1. US ECONOMIC DATA: According to CNN Money:

Consumer prices jumped in April, sparking a fresh round of inflation worries on Wall Street, and economists say the report gives investors and the Federal Reserve good reason to worry.

The Consumer Price Index rose a surprising 0.6 percent in April, the Labor Department reported, compared with the 0.4 percent rise in March. Economists surveyed by Briefing.com had forecast a 0.5 percent rise in the government's key measure of inflation.

The so-called core-CPI, which excludes often-volatile food and energy prices, rose 0.3 percent, the second straight month that the closely watched reading came in at that level. Economists had forecast there would be only a 0.2 percent in core CPI in April.

The Core CPI # is especially important to the fed because this reading excludes the volatile food and energy markets and provides insight into the level of inflation that is actually beginning to hit our nation. The comfort level is about 2% for the Fed, although in reality core inflation is now up 2.3% over the past 12 months; something to worry about if you are a fed governor or chairman!

2. Energy Markets: A week ago I predicted a correction in the energy markets to the low 60's for oil; which looked like a winning prediction until that Iran letter turned out to be more damaging than peaceful. Since, the inventories of light sweet crude and gasoline have jumped a bit higher than expected bringing with it some selling pressure in these markets.

According to CNN Money:

Oil slid towards $68 a barrel on Thursday, pressured by rising U.S. gasoline inventories and concern that high energy costs are leading to inflation that could slow demand. U.S. demand for crude and petroleum products in April fell by 1.5 percent from a year earlier, with high pump prices cutting gasoline use by 1.9 percent, industry figures showed on Wednesday.

Combine these inventory gains with the OPEC minister's sort of bearish longer term forecast for oil demand and you are seeing some speculators and traders take some profits off the table.

But wait! We still have geopolitical concerns in Iran & Nigeria that could change these markets at any moment, and in any direction. This fact will keep these markets volatile until we get a clearer picture of what is really going on in these two countries. In meantime, expect a trading range of about $66 - $73/Barrel for light sweet crude oil; any drop below or above should be a signal of deeper fundamentals kicking in.

For the fed to PAUSE at the next meeting we will need the price of oil to drop to $60/Barrel or below! I recently suggested a price under $68/Barrel but no longer think that is low enough to warrant a pause by the fed in June!

NEXT FED MEETING: June 28-29th

WHAT TO EXPECT: Lets do it this way. If the news out of Iran & Nigeria remain generally positive (i.e. no more violence in Nigeria and just no news out of Iran will suffice) and the price of oil drops to about $60 or below, than I am 75% sure the fed will PAUSE to wait for future economic data.

However, if news out of Iran and Nigeria continues to be negative and uncertain and the price of oil hovers above the $68/Barrel mark, then I am 85% or so sure that the fed will tighten again by 1/4 point bringing the fed funds rate to 5.25%.

HOW IT AFFECTS HOUSING: Should the fed raise by 1/4 point again in June than expect lending rates to trickle higher for an extra few months down the road and buyers to feel a bit more pressure to buy NOW rather than wait. A 1/4 point rise should be enough to continue the slowdown that is affecting most of the nation; especially overheated highly speculative markets such as Miami, Phoenix, Las Vegas, Boston, & Los Angeles.

If the fed pauses then expect a short term positive rally (which might present itself by providing a bottom in today's slowing markets) with media coverage suggesting 'the end may not be near' style of articles. After that initial jubliation, expect a flat to down market for as long as lending rates continue to trickle higher; which should be another 6-10 months or so. Once we hit a top in lending rates the housing market will flatten out until we get a clear picture on what the next long term fed move is going to be. Should the US Economy start to show signs of an impending recession, the fed will act quickly to stimulate the economy by lowering interest rates and bringing lending/borrowing costs down again!