The question of a Fed pivot isn’t if, it’s when because the FOMC can’t continue to hike rates indefinitely. In that scenario, economic activity would grind to a halt and recede, 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 labor market support.
In this light, the FOMC needs to contain inflation not destroy it and that means a careful balance of policy. The question of when the Fed will pivot is a different story and it may be sooner rather than later.
Economic Activity Lags FOMC Policy By 1 to 2 Years
It is a generally accepted phenomenon that central bank policy takes 1 to 2 years to take effect. This is because the big spending budgets that are impacted by central bank policies are usually set well before the policies are put in place and those policies are changed ever so slowly (usually).
Because the first post-pandemic interest rate hike was put in place in March 2022 it’s likely the true impact of the first interest rate hike is yet to be felt. Now, 8 months and 350 basis points of increase later, it won’t be until late in 2024 that the impacts of what the Fed has done to date will be fully integrated into the economy. And they are still raising rates.
The latest indications from the Fed are that 1) they will (or could) slow the pace of interest rates as soon as next week and 2) the peak of interest rates could be higher than the market is forecasting and may stay at that level for longer than anticipated.
In the first scenario, the FOMC is already pivoting or trying to pivot in case they’ve already gone too far. We’ll call this the first pivot. In the second scenario, they leave the door open for an even more aggressive policy that may not fully impact the US and the global economy until well into 2025 and that’s where the 2nd pivot will come into play.
Expect A 2nd Fed Pivot Sometime Late In 2023.
The FOMC likes to cling to its data and that is a good thing. If they’d done that in early 2021 when inflation started to increase maybe we would be where we are now. The point is that inflation is so hot and has been running so high for so long that the FOMC needs to be sure it’s tamped down.
The talk from that quarter is rates will need to come down to at least 2% to make them happy and, by that time, they may well be behind the curve once again. The target rate indicated by the CME’s Fedwatch Tool is 475 to 500 basis points by July 2023. That will have sent the US economy into a recession that is being led by the housing sector.
When this data shows up in the broader 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, easier policy.
The question now is how bad will the downturn 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 current year, Toll Brothers (NYSE: TOL) F23 guidance is indicating a 15% to 23% decline in volume sales compounded by an 11% decline in home prices.
This is bad news for home builders, home sellers and every industry affected by the home building industry which is virtually all of them.
When Will The FOMC Pivot?
The FOMC is trying to pivot now, but the data may not let them. If consumer-level inflation doesn’t stay down or if it lingers at new lower but still high levels the Fed will be forced back onto the track of interest rate hikes. The risk for the market is that economic activity will contract so quickly and/or so sharply the FOMC will be forced to pivot again and start cutting rates. So much for them being in charge of the money.
