The market is pricing in a 100% probability of a quarter point rate hike on Wednesday by the Federal Reserve. This will be the third quarter point rate hike this year.
The Fed has already hiked rates too fast IMO. Let’s look at the fundamental economic data and three reasons why the Fed should immediately stop hiking rates.
3 Reasons Why The Fed Should Stop Hiking Rates
1. Housing Market. The housing market drives the entire economy. The NAHB Housing Market Index has dropped to 67 from 68 in the prior month as home sales slow from rising interest rates. Existing home sales have dropped 5.34 million from the previous month’s 5.38 million. The slowdown in pending home sales MoM is picking up from the previous monthly reading of -0.5% to the currently reading of -0.7%. New home sales has dropped from 631K to 627K.
2. Manufacturing and Services. Manufacturing is slowing down because rising interest rates have pushed up the US dollar so high that we’ve put our manufacturing exports at a big price disadvantage. Industrial production growth fell from 0.6% in the previous month to 0.4% in the most recent month. The trade balance has widened as US products lose out to cheaper foreign products. The trade balance widened from -43.1 in the previous month to -50.1 in the most recent month. ISM Services fell from 59.1 to 58.5 in the most recent month. ISM Manufacturing was up slightly from 60.2 to 61.3, but that was probably the result of ISM Manufacturing prices falling 76.8 to 72.1 as manufacturers drastically cut prices to get rid of some of their inventory as they cannibalize profit margins just to move product.
3. Inflation. What inflation? Aggregate demand is not picking up which is deflationary. Core CPI MoM was 0.2% in August. In September the number was 0.1%. The CPI YoY was 2.9% in August. In September the CPI YoY fell to 2.7%. There is no increase in inflation because aggregate demand is not picking up. Why is the Fed still hiking rates when inflation is already falling? Trade wars are artificially pushing up (cost-push inflation) the PPI which came in at 3.4% YoY in August. In September the PPI fell YoY to 2.8%. Why the drop? There are more tariffs on more goods now than ever so why is the PPI falling? The PPI is falling because Fed interest rate hikes have significantly slowed aggregate demand.
Powell Press Conference and the U.S. Dollar
September is when we get the Powell press conference after the FOMC announcement. The Fed will update its forecasts. The Fed wants to hike rates again in December, and then hike rates 3 more times in 2019. The forecast will let us know the pace of tightening beyond September. If Powell’s language changes and he suggests that it’s time to slow down because of the three reasons I mentioned above, the U.S. dollar would plunge as the December rate hike might not happen. But if the Fed stays the course and remains hawkish, the dollar may surge higher against most other currencies which would really hurt emerging markets. Keep your eyes on the U.S. dollar and UUP as the rate hike is announced. Don’t jump too quick because someone flings the rumor that the Fed is much more dovish now. Active traders have all been headfaked by UUP on an FOMC announcement. What happens is that sometimes breaking headlines about the Fed being dovish or hawkish create spikes on UUP but then UUP adjusts as the headline turns out to be fake and the market digests all available information over time.