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How Soon Will the Fed Reverse Course on Rates?

By Cameron Street - Exclusively for ERATE

(June 28, 2008) Could a Fed rate hike occur at its next meeting in August or is it still months away? At the recent June meeting, the FOMC decided to keep rates on hold for the time being leaving the Fed Funds rate at 2% after it was last cut on April 30th following seven consecutive rate cuts since September of 2007, spanning a period of time where the Fed has exercised its most rapid series of rate cuts in several decades by shaving rates a total of 3.25%. The Fed may have concluded the economy is less likely to experience a severe contraction and that the risk on the inflation side may pose a greater threat currently. Yet recent reports also point to the fact that both the housing and manufacturing sectors may not be able to withstand an increase in borrowing costs at this time. New home sales recently fell to the second slowest pace since the early 1990s and contrasted with the period one year earlier, new home sales were down 40%. The overall inventory of unsold homes remains at a near 11 month supply.

It appears the broader economy is trending towards a weakened condition. Consumers are falling behind on more than mortgage debt now, as delinquency rates on consumer loans are rising as the consumer is pinched from both the housing side of the equation as well as seeing other expenses rise with inflation and their discretionary income plummet. A debt overloaded consumer could spark even more problems for the beleaguered banking industry as delinquencies spread into credit card, home equity and the auto loan segments as well. Businesses are also feeling the pinch along with the consumer. Durable goods orders in April were revised down an additional 1% and new orders have reflected the first drop in three months. Autos and machinery were among the goods experiencing a rapid fall off in orders. As durable goods orders drop off, this decline works to offset any gains coming from exports. Many economists are in the process of lowering their forecasts for the second half of the year while the first half may have faired slightly better than anticipated. The best path for the Fed to follow, as the uncertain outcome for the U.S. and global economies unfolds, may be to adopt a wait and see approach and apply patience rather than adopting an overly reactive approach.

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