On paper, this should have been an easy call for the Fed…
Third-quarter GDP came in at a strong 3.4%.
Headline inflation moved higher.
Under normal circumstances, that combination gives policymakers a pretty straightforward reason to raise rates. But they didn’t. And when you dig underneath those headline numbers, you can see why.
In today’s Moneyball Economics, I’ll show you the data I think the Fed is watching most closely, why the inflation picture is less threatening than it first appears and the one wildcard that could completely change the rate outlook over the next few months.
Click below to start the video:
Video Transcript:
Hello, fellow Moneyball economists. I’m Andrew Zatlin.
This week was pretty much the poster child for why we track the economy. Developments in the economy directly determine where the Federal Reserve is going to take interest rates.
And let’s face it, interest rates, that’s where the rubber hits the road because interest rates affect everybody directly. It hits the housing market with mortgage rates. It hits the auto market with auto loans. It hits retail with credit card spending. It hits the stock and bond markets. And this week we got the kind of economic data that should have triggered a rate hike. But instead, the Fed decided this week not to raise rates and in fact signaled it’s time to wait and see.
To understand why this strong economic data did not create a rate hike, let’s dive into the data itself starting with the GDP. Third quarter GDP came out and it was rocking and rolling 3.4%.
That is a strong, vibrant economy. And before you say, “Well, wait a second, maybe it’s strong year over year because last year was weak.” No, my friends, last year was also strong. I think it was about 3.6%. You’ve got strength sitting on top of strength. And there are some critics out there who are poo-pooing these numbers saying it’s all because of AI spending. And certainly AI spending was a major contributor, but that’s only half the story.
See, AI spending and investing was up, but it’s all imported and that pulls things down. And so you’ve got two offsetting things happening. This 3.4% GDP was strong because the economy is strong. Well, that then suggests that we’re going to see inflation because if there’s strong demand, it tends to pull up prices and indeed inflation was up. Economics 101 would say, well, wait a second, strong economy, inflation moving up, it’s time to raise rates.
So what did the Fed see that made them more cautious? Well, it has to do with headline inflation’s up, but there’s some nuance here. Headline inflation’s up. A lot of that’s because of gas. Excuse me. All of it is because of gas prices. The core inflation, which ignores food and gas prices actually tilted down a little bit.
It looks like whatever’s happening underneath the fuel price story has started to mellow out and that’s where the Fed wants to focus, but that’s not the only part of the story. If all of this extra inflation is coming out of gas prices, then nothing the Fed does will affect it because gas prices, that’s determined at the global level. That’s basically stemming from what’s going on in Iran. The Fed could raise interest rates all day long. They’re not going to bring down that inflation whatsoever. It’s futile.
What they will do though is slow the economy in a bad way. They’re going to hit the consumers and that’s of concern.
Remember, they just raised interest rates, but they did it in kind of a sneaky way. They raised interest rates at the end of September and everybody ran around saying, oh my God, that’s going to kill the housing market. That’s going to slow the economy. It doesn’t.
It doesn’t because by waiting till September to raise rates, mortgage rates go up, but who cares? Nobody’s buying homes in October, November. So it’s kind of a nothing burger. It doesn’t really affect the broader economy at the level that people are afraid of.
Well, fast-forward to next year, if you come in in February and March and these rates are still high, or if they, God forbid, raise it again, you’ve killed the housing market and that is 30% of the economy.
So the Fed is trying to juggle all these elements.
Looking at the consumer, you raise interest rates right now, that’s another set of data that came out and that data is saying the consumer is in pain. The consumer is now at a pivotal point where they have been overstretched. If you take a look at the savings data that came out and you compare it to the disposable income that came out, what you will see is really concerning.
Disposable income, that’s the money you get after taxes and all the nonsense. That’s how much money you have to spend. Now, some of that you can say, well, look at this chart. The amount of money people are saving relative to the amount of money they’ve got has gone down, down dramatically, and no sign of a bottom yet. That is the first sign that people are struggling to make ends meet.
They don’t have enough leftover money to put into the bank account.
In fact, if you take a look at how much consumption is relative to how much disposable income there is, compensation, wow, people are spending more than they’re earning at an all-time high level over the past few years. Consumers are under strain. You raise interest rates, they’re going to feel it and they’re going to respond immediately. They’re going to pull back. That is how you get to a recession.
So the Fed is reading the tea leaves correctly. They’re saying, yes, economy’s strong. Inflation’s not really strong, not when you really dig into it. It’s not the kind of inflation we can influence. Also, I believe that a lot of this inflation goes away when gas prices start to mellow out and they’re probably going to mellow out in a couple of months. I’m not saying that because of what’s going on with Iran and whether we do something there.
I’m saying it’s simply because by the time we get to March, if the price of oil is a hundred bucks a barrel, that’s what it was last year in March. So just the simple math, year over year, there’s no more year over year inflation. It’s the way the math works.
Bottom line, the next few months are unclear what happens with the interest rate hiking. I believe the economy continues to go up. I believe inflation maybe it flattens, which might release some of the pressure to raise rates, but I also believe that the consumer’s in trouble.
The only way forward for the consumer is some kind of wage or salary increase, and that is the wild card coming up. Our bonus is going to be strong in the next month or two. Our salary raise is going to be strong in January, February. We don’t know.
If they do come out strong, and I do believe they will, then the Fed might second guess raising rates and say, “It’s fine, we can raise rates.” The consumer spending will move forward. So there’s a lot of moving parts here, but suffice it to say, I don’t think we’re going to see a rate hike next month either. That’s my guess though.
In the meantime, I wish you nothing but luck. The stock market’s getting slammed. Nothing to do with the non-rate hike though. Let’s see what happens next month when we’re past midterms, when we’re past earning season, and now we start off again.
We’re in it to win it, folks.
Zatlin out.
