Reports Show Stumbling Economy Ahead of Fed Rate Decision

The Federal Open Market Committee got a last glimpse into the economy ahead of Wednesday’s policy announcement, and the picture was of slowing growth and decelerating inflation pressures.

Reports showed the housing market struggling, wage increases slowing, consumers growing gloomier, and manufacturing in one region of the country faltering. Taken together, Wednesday’s data points to “sluggish growth, cooling wage pressure and a still soggy, but not collapsing, housing market,” Robert Kavcic, senior economist at BMO Capital Markets, said in a commentary. 

In addition to the reports on the state of the U.S. economy, the International Monetary Fund showed an improved outlook for global inflation.

However, these factors weren't enough to shift most Federal Reserve watchers' expectations for a 25-basis-point rate hike on Wednesday. The mounting evidence of an economic slowdown could have a greater impact on the future path of Fed policy, although experts disagree on how much and how soon Fed officials will be swayed.

Slower wage growth, in particular, could encourage the central bank to back off of rate hikes sooner rather than later, said Ian Shepherdson, chief economist at Pantheon Macroeconomics, in a commentary. 

“The message now is clear: The Fed should not tighten further,” he said. “We are raising the chance of no hike in March to 70% from 60%.”

That would be a departure from what the Fed has signaled it will do. At the December meeting, Federal Open Market Committee members forecast that interest rate hikes would only halt after two more 25-point increases after February, which would bring the rate to the 5%-5.25% range.

The Fed is likely to stick to its plans to continue hiking rates at its next few meetings despite the sagging economic indicators, Joe Davis, Vanguard Group’s global chief economist, said in a commentary. 

“The Fed are battling market, household, and business expectations and if they were to come up short of their stated terminal rate, it may negatively impact their credibility and ability to respond effectively if inflationary pressure reemerges,” he wrote.

S&P CoreLogic Case-Shiller Home Price Index

The measure of nationwide home prices fell for a fifth month in November. The 0.3% drop in the index highlights the toll that the Fed’s rate hikes and the consequent spike in mortgage rates have taken on the housing market. Year-over-year price appreciation fell to 7.7% from 9.2%. Prices have now fallen 3.6% since peaking in mid-2022. 

"Higher mortgage rates and rock-bottom housing affordability are crushing the U.S. housing market,” Matthew Walsh, an economist at Moody’s Analytics, said in a commentary.

Falling home prices could have a big impact on overall inflation and the Fed’s response to it later this year, said James Knightley, chief international economist at ING, in a commentary. 

“In an environment of recession and on-target inflation, we expect the Federal Reserve to be cutting interest rates aggressively from later this year,” he said.

Employment Cost Index

Employment costs for private employers, including wages and benefits, rose 1% in the fourth quarter of 2022, the Bureau of Labor Statistics reported. That was the slowest pace since early 2021, and less than economists expected. 

Wages and salaries are now up 5.1% over the year—a slowdown from their peak of 5.7% in the second quarter of 2022. While rapidly increasing wages benefit workers’ budgets, the Fed wants to see those raises diminish for fear of a “wage-price spiral” feedback loop between prices and salaries. Fed Chair Jerome Powell has voiced concerns on several occasions that a spiral like that would stoke out-of-control inflation.

The new wage data should reassure Powell and other decision-makers that the threat of such a scenario is “no longer realistic,” Shepherdson, the Pantheon economist, said in a commentary. 

Consumer Confidence

Consumers grew more pessimistic about the future prospects for their own finances and the broader economy in January, defying economists' expectations that the outlook to improve. 

That’s according to the Conference Board’s Consumer Confidence Index, which ticked down 1.7%, showing people are bracing for bad economic times on the horizon. The part of the index measuring future expectations dipped to a level that’s historically been associated with approaching recessions, the board said. 

Consumer confidence is an important indicator because it is thought to influence people’s decisions on spending—and consumer spending is the engine that drives much of the country's economic growth. 

Despite gathering fears of an impending recession, the survey showed consumers still have a rosy assessment of the job market—a factor that will work in favor of the Fed staying the course on its rate hike plans, Katherine Judge, director of economics at CIBC Capital Markets, said in a commentary.

Chicago Business Barometer

The measure of manufacturing activity in the Chicago area, considered a leading indicator of the direction of the U.S. economy, fell to 44.3 in January—the fifth month in a row the index has stayed below 50, which signals that business is shrinking. The index is based on a survey of purchasing professionals in the manufacturing industry.