The statement which the Fed released at the close of the FOMC meeting sounded a lot like the one from August: "moderation in growth"... "cooling of the housing market"... "readings on core inflation elevated"... "some inflation risks remain." As with last time, the decision to hold short-term rates unchanged was not unanimous.
What wasn't included this time, though, was a characterization that the housing market was cooling "gradually." Also absent was the assertion that "lagged effects of increases in interest rates and energy prices" were contributing to the slowdown. Housing seems to be cooling more quickly than the Fed anticipated, perhaps, and the effects of previous interest rate increases and high energy costs appear to be part of the picture now.
The National Association of Home Builders knows that housing has cooled; their index of sentiment among its members for September fell to a reading of 30, the lowest mark since 1991. Home sales have fallen from peak levels last year, with declines of over 20% from year-ago levels. In equities, a 20% decline is considered a correction, especially when it comes from all-time record levels. No one disputes that home sales have weakened in the absence of cheap interest rates and speculator fever, but the fundamentals of demographics and such still remain pretty good -- and may be improving -- once the correction has run its course, excess inventories work off, and incomes catch up with home prices.
That hasn't yet happened, though. For August, starts of new homes declined by 6% to 1.665 million (annualized) units begun. Building permits also notched lower, slipping 2.3% to 1.722m annualized units. Those numbers were lower than expected, but with unsold inventories of new homes at high levels, builders have no reason to add more stock. Reports covering sales of new and existing home are due out next week and will probably show declines as well.
Aside from slipping economic growth, moderating inflation is central to the Fed's ability to hold rates steady. For the second consecutive month, the Producer Price Index blipped higher by the barest amount, an increase of just 0.1% for the overall PPI. "Core" measures of PPI, exclusive of the most volatile components such as energy costs, managed a decline of 0.4% for August. In the past three months, annualized rates of PPI headline inflation have fallen from 4.8% in June to 3.6% through August, and "core PPI" has moved from 1.9% to 0.9% over that spell. Other PPI measurements at differing stages of production do reflect still-high prices, which may yet be passed along.
The Fed's decision to leave rates alone caused little stir, as it was a widely-expected inaction. What was unexpected was the amount of weakness revealed by the Philadelphia Federal Reserve's report on manufacturing conditions in its district. After largely humming along for months, the index nosedived from a warmly positive 18.5 mark in August to -0.4 in September, a virtual shutdown of activity. Although one reading doesn't begin to make a trend, bond markets took this news as a sign that softer growth in housing might be infecting other sectors of the economy. Looking at the last three months of the Philly Fed index for clues, the index has been a little erratic during the summer, moving from 6.0 in July to 18.5 in August to -.40 in September, so perhaps the issues are related to very specific industries in that district, rather than indicative of a larger problem. A broader reading of manufacturing health comes from the ISM after the turn of the month, but next week will give us a reading from a local Chicago group which may provide some clarity.
The Fed remains on hold, waiting for data to bear out their forecast of both slower growth and waning inflation. This week, inklings of both of those seemed to appear, and the softer economic news saw the bond market starting to place bets on when the Fed will begin to cut interest rates. Futures markets seem to point to March as a likely prospect, but some believe there's a chance of a rate cut as soon as December. We think it's way too early to speculate about any easing in monetary policy, especially since new factors are coming into play, such as sharply lower energy costs and market-engineered lower interest rates.
The weak economic data gave spark to a strong rally in Treasuries, and the 10-year Treasury which especially influences fixed mortgage rates saw its yield fall from 4.73% at the close of business Wednesday after the Fed meeting to about 4.60% at the close Friday. That's a pretty good rally, and mortgage rates will be falling as this week kicks in. Like many rallies, a partial reversal may happen, especially if the data fail to reinforce the big declines seen last week. Several looks as manufacturing, final 2nd quarter GDP readings, orders for durable goods and more dominate the calendar, and we'll expect maybe a five basis point decline in the average 30-year FRM.
