Fed Likely on Hold in November as Mideast War and Strike Uncertainties Roil the Outlook
The economy faces a complex mix of upside and downside risks. Principally among downside risks, the Israel-Hamas War threatens to interrupt Mideast energy exports, spurring a new global inflationary shock. In addition, the UAW and actors’ strikes, the possibility of a federal government shutdown, and the restart of student loan payments are incremental negatives with uncertain impacts. The longer strikes continue or the government shuts down, the more the economy will slow. Comerica’s October forecast assumes the UAW strike ends by the end of October, the SAG-AFTRA strike ends in the fourth quarter, and the government shuts down for no more than a few weeks this quarter, causing slower growth around the turn of the year but not an outright contraction of real GDP.
At the same time, business cycle fundamentals are becoming more supportive of a continued expansion. Job growth remains resilient, incomes are outpacing inflation, and housing prices are stabilizing and adding to household wealth and spending power. Core CPI has moderated to the lowest in two years as slower increases in house prices and rents translate to less pressure on household budgets, and as car dealers and retailers of other durable consumer goods roll out discounts. U.S. energy companies delivered an upside surprise to the outlook in early October, too, when domestic oil production rose to a new record high. Higher U.S. gasoline inventories are countering the effect of political risk in the energy market and keeping gasoline prices lower in October than in August or September. And investment in new manufacturing facilities is booming as companies take advantage of big federal subsidies for the renewable energy supply chain.
The minutes of the Fed’s September Open Market Committee meeting signal that the committee plans to “proceed carefully” near-term, since interest rates are already pushing down multifamily housing starts and slowing other capital-intensive activities. The Federal Reserve will likely hold the federal funds target steady at their next decision November 1. Another rate hike is still possible around the turn of the year if a combination of Mideast turmoil, strikes, or other events delivers another upside shock to prices. But it is a close call, and many FOMC members are talking about holding rates steady instead of making a last increase of the cycle. Either way, the Fed is likely to pivot to interest rate cuts in mid-2024 as core inflation and wage growth continue to moderate.
Long-term interest rates continue to rise, with the 10-year Treasury note yield up in October to the highest since 2007. There are a number of upward pressures on long rates: A big federal budget deficit; a clearer path for the economy to return to low inflation without a recession, supporting a less inverted yield curve; and perhaps foreign central banks selling dollar-denominated reserve assets to bolster their currencies. These upward pressures will likely persist into 2024, keeping long-term Treasury yields and mortgage rates relatively high.
