The question of a Fed pivot point is not if, but when, because the FOMC cannot keep raising rates indefinitely. In that scenario, economic activity would grind to a halt and decline, GDP would shrink, and the global world order would collapse. No, the FOMC’s mission is to maintain economic stability through price stability and its dual mandate of supporting the labor market.
In this light, the FOMC to control inflation not destroy it and that means careful policy consideration. The question of when the Fed will pivot is another story and it may be sooner rather than later.
Economic activity is 1 to 2 years behind FOMC policy
It is a generally accepted phenomenon that central bank policy takes 1 to 2 years to take effect. This is because the large spending budgets affected by central bank policies are usually established long before policies are introduced and those policies are (usually) changed very slowly.
Since the first post-pandemic rate hike was introduced in March 2022, it is likely that the real impact of the first rate hike has yet to be felt. Now, 8 months and 350 basis points of increase later, it won’t be until late 2024 before the effects of what the Fed has done so far are fully integrated into the economy. And they are still raising rates.
The latest indications from the Fed are that 1) they will (or may) slow interest rates as early as next week and 2) the the peak of interest rates could be higher than the market predicts and may remain at that level longer than expected.
In the first scenario, the FOMC is already pivoting or trying to pivot in case they’ve already gone too far. We call this the first pivot. In the second scenario, they leave the door open for even more aggressive policies that may not fully affect the US and the global economy until well into 2025, which is where the 2nd pivot comes into play.
Expect a 2nd Fed Pivot sometime in late 2023.
The FOMC likes to stick to its data, and that’s a good thing. If they had done that in early 2021, when inflation started to pick up, we might be where we are today. The point is that inflation is so hot and has been so high for so long that the FOMC needs to be sure it is curbed.
The talk from that quarter is that rates have to go down to at least 2% to make them happy and they might be behind the curve by then. The target rate indicated by the CME’s Fedwatch Tool is 475 to 500 basis points by July 2023. That will have pushed the US economy into a recession led by the housing sector.
When this data comes out in the wider economy, the Fed will have to start cutting rates because, guess what, it could take up to 2 years for economic activity to catch up with the new, simpler policy.
The question now is how bad the downturn will be. The word from the C-suite is that it could be very bad and the housing data backs that up. While strength was shown in the current quarter and year, toll brothers (NYSE: TOLL) F23 guidance indicates a drop from 15% to 23% in volume sales compounded by an 11% drop in house prices.
This is bad news for home builders, home sellers and every industry related to the housing industry, which pretty much all of them are.
When will the FOMC run?
The FOMC is now trying to pivot, but the data may not allow it. If consumer-level inflation does not stay low or if it lingers at new, lower but still high levels, the Fed will be forced to return to rate hikes. The risk to the market is that economic activity will contract so quickly and/or so much that the FOMC will be forced to pivot again and cut rates. So much so that they are in control of the money.