The US Consumer’s Other Big Worry
Besides rising oil prices and a housing slowdown, there’s at least one more factor that can hurt US consumer spending – the Federal Reserve.
Rising interest rates do hurt the consumer. It takes more money to pay credit card bills, adjustable rate mortgages go up, it costs more to borrow money and so on. And rising short-term rates are not good for the profits of most corporations.
This Fed is determined to raise rates. There are three more Fed meetings this year: September 20, November 1, and December 13. Right now it looks as if they are going to raise rates at each meeting. The market certainly thinks so, and recent speeches and Fed releases suggest so as well, at least for two more hikes.
Three rate hikes would take the Fed funds rate above the current price of the ten-year bond if longer-term rates stay where they are today. What worries me is that if the bond market is convinced we are going to see three rate hikes to 4.25%, why would they take a mere 4.21% on a ten-year bond, unless they thought that ten-year rates were going to drop at some point?
Today, the economic data is fine. August is going to be another solid month in GDP growth. Jobs will be OK. Housing, while slowing, is still at a torrid pace. The Fed will meet this September and feel they have plenty of cover to raise rates.
I think they should hold off for at least one session and let's see some more data. Let's see if the rise in housing inventories is for real or just an end of summer slump. Let's see if energy prices are going to slow things down a little on their own without piling on with another rate hike. I don't see the need to be in a rush. They have taken over a year to raise rates slowly, at a very measured pace. If there was a need to curtail inflation, they should have acted faster. In fact, core inflation is well contained. Yes, energy costs are way up, and understated in CPI, but they are ultimately a drag on the economy.
If November comes around and the economy is still strong or inflation is rising or the housing market is still too strong, then go ahead and raise rates. Raise them 50 basis points if you feel the need to "catch up."
The trends (and forward data) suggest the economy could be getting soft late in the year or early next year. More than one economist, many of them normally quite bullish, thinks we see a slowdown to 2-2.5% GDP in the first quarter of next year. If that is the case, we do not need to slow the economy down any more by raising rates.
Add in concerns about a very flat growth in the money supply in both the US and Japan and you have even more reasons to pause for a meeting.
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If the Fed keeps on this path, we are at risk for a recession in the second half of 2006. I cannot imagine the Fed raising rates until they invert the yield curve on their own. But if on November 1 we see a 4% Fed funds rate, or on December 13 a 4.25% rate, it would not take too much in the way of a slowdown for the bond market to push long rates down.
My take? The Fed is going to ignore everyone calling for a pause and go right on until at least a 4% rate. Friend Barry Ritholtz of Maxim said on CNBC (Kudlow & Company) that he thinks Greenspan wants to give the next Fed chairman some room to cut rates in the next economic slowdown. Maybe, Barry, but I don't think so. It is a secondary benefit. The real reason Greenspan and company are raising rates is that they are worried about a housing bubble. They want to make sure it does not get much bigger.
I agree that is a very serious, even worrisome, concern. But if the data is showing the problem may be correcting itself, through gravity if nothing else then we don't need to shove it faster down the hill. Patience. We don't need to kill anything yet. It may be dying of its own accord.
In short, I am worried about the Fed doing what they have done so many times in the past. They raise rates too much and for too long and we slide into recession. There is no need for us to go into a recession next yearRecessions are a bitch. Just a mid-cycle slowdown like 1994-95 would be fine with me. We will of course see what happens in the fullness of time, and my guess is that we will have some warning. We won't just roll over and find ourselves in recession one month. It will creep up on us just like the last few times.
We will watch the yield curve, watch the housing and the bond markets, consumer spending, energy and all the rest. The clues will be there.
And if we have a slowdown, we can blame energy and housing. If we have a recession with short rates at 4.25% or higher, we can blame a too aggressive Fed.
In any event, slowdown or recession, you do not want to be long the stock market, except for certain select stocks and sectors (like energy). This is the time to be cautious. There is another major bull market in our future. Save your powder. It is hard, I know. But you will be happier than trying to make something happen.
By John Mauldin
John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. To subscribe to John Mauldin's E-Letter please click herehttp://www.johnmauldin.com/
