US Economy - Pain on horizon?

The Chairman of the Federal Reserve Jerome Powell should be relieved. Fed held the interest rate at 5.5% on 1st November, avoiding yet another increase. There have been a couple of other economic releases since then that vindicate the stance the Federal Reserve has taken with regard to interest rates.

One was the Non Farm Payrolls which was expected to be about 180K but actually came in at 150K, which was a big downside surprise. The other was the ISM Services PMI was expected to be 53 but came in at 51.8. Under normal market conditions, both these results could be interpreted as being bad for the economy. However, these are not normal market conditions and as such were interpreted as an indication that the Fed's policies have started showing results. This conclusion might be a bit premature and a few more months need to be factored into the results. The Fed has been having a hard time containing inflation, which has been extremely had to bat down. Inflation has remained elevated beyond what the Fed should be comfortable with and the market is starting to accept the "higher for longer" mantra.

Economic activity expanded at a strong pace in the third quarter, but dark clouds remain over the horizon. Tighter financial and credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. Jerome Powell in a speech said "In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective."

Contrary to a notion that doing the rounds a few months ago, the Fed clearly intends to stick to the 2% target for the interest rate. A lot of pain still has to be endured before that becomes a reality. In spite of the current dip, employment is still too high and household spending still remains high. For the first time in decades, the rent-to-income ratio reached 40 percent, which means that people spend 40 percent of their take-home pay on housing. Rents are expected to remain high as long as would-be homeowners keep being priced out of the homeownership market because of higher interest rates. Mortgage rates are at a two-decade high; the average rate on a 30-year mortgage was 7.8 percent as of last week, up from 6.7 percent for an identical loan in October 2022.

The question of cutting rates is not even being entertained by the MPC as of now. Fed will be forced to visit a lot more pain by way of pursuing policies which will lower employment, pump up mortgage rates and reduce household spending.