Interest Rate Update: Fed Will Hold
A: Been a little while since I talked about monetary policy. The main reason has been that I was waiting for some more economic data to come out to get a clearer picture of what the fed might do with interest rates. The bottom line, expect the fed to keep rates where they are for some time.
The fed has been on hold for a few quarters now while officials guage the effects of past rate hikes on the economy. The ultimate goal was to keep inflation from infecting economic growth. Today's CPI report seems to confirm this with one issue: ENERGY PRICES. The price of energy has fallen nicely from earlier year record highs and remained there. The results are now being felt in economic data. As the cost of energy falls, corporate profits rise and inflationary pressures ease a bit.
According to today's Yahoo Finance article titled, "Falling Gas Prices Help Push CPI Down":
Consumer prices, helped by another huge decline in gasoline pump prices, fell for a second straight month in October, providing more relief to Americans battered earlier in the year by soaring energy costs.Meanwhile the US economy seems pretty strong. The labor market is very healthy and wages are strong; which is why stock prices continue to rise.The second 0.5 percent fall in consumer prices was better than the 0.3 percent dip that many analysts had been expecting. And core inflation, which excludes volatile energy and food prices, was also well-behaved, rising by just 0.1 percent, the smallest gain in eight months.
The news on inflation was certain to cheer officials at the Federal Reserve.
There is only one problem with all of this. That is, what we are experiencing now (higher stock prices and tamer inflation data) are largely due to the drop in energy prices and specifically light sweet crude oil from $76/Barrel to $59/Barrel today. Here is a 1-Year chart showing the drop that oil has had in relation to when it was at record levels:
What happens if this winter is colder than expected and stockpiles of fuel reserves start to fall? What happens if geo-political concerns in Iran, Nigeria, Venezuela, or Iraq worsen causing a supply imbalance of oil? What happens if consumption starts to rise again?
Well according to CNN Money's article today titled, "Oil inches over $59 on Strong Demand":
Distillates stocks in the U.S. fell by 3.6 million barrels last week, nine times more than forecasts, while gasoline supplies dropped by an unseasonably high 3.7 million barrels, the Energy Information Administration (EIA) said on Wednesday.Its hard to predict the future direction of oil right now other than to say that it is stuck in a tight range between $58-$60 or so a barrel. And that is just fine! As long as the price of energy does not skyrocket back to the mid $70's, expect inflation data to be relatively tame and the fed to STAY PUT with interest rates going well into 2007."The strong demand in gasoline and distillates is very surprising," said Tetsu Emori, chief strategist at Mitsui Bussan Futures.
Total U.S. oil demand is up 4.8 percent from a year ago, the data showed. Demand for distillates is up 9.5 percent.
"If the trend lasts a few weeks, prices may be taken higher. But crude oil inventories are still very high so the potential upside could be limited."
If you were expecting a recession in early 2007 resulting in the Fed cutting interest rates and making mortgage/credit/auto payments cheaper for everyone, then I think it's time you wake up to realty. If there is a recession coming then why is the stock market rallying to new highs? Remember that the stock market is a LEADING INDICATOR of the economy while rate hikes/housing data/energy prices are LAGGING. To get the best idea of where the US economy is heading in the short term, you should look at what stock traders are betting on.
HOW THIS WILL AFFECT HOUSING: With the fed on a short-medium term HOLD with interest rates, expect mortgage rates to remain at levels they are at today, with minor fluctuations. Any new buyer demand as a result of lower mortgage rates will NOT OCCUR until the beginning of 2008 at the very least; and that is assuming the fed starts to cut rates in mid-2007 which is not a sure thing yet. If you recall, I talked about when to re-enter the housing market and included "...when the fed is nearing the end of a rat-easing campaign" as one of a few key peices of data to look for.
Consider the drop in oil a godsend for those with resetting ARM's and other types of adjustable mortgages as without this price drop the fed will have most likely raised interest rates again by 1/4 point at one of the next 2 meetings. Instead, it seems the fed has found a sweet spot with the fed funds futures at 5.25% that is neither restricting or stimulating the current economy.
WHAT TO WATCH: The price of oil. If the price of oil rises to above $70, expect the stock markets to give up their recent gains and future economic data to show inflation becoming a threat again.
For a more in depth look at what I discussed here, read CNN Money's article titled, "Beware: No Rate Cut Until 2008" which points out details from the minutes of the last fed meeting.
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