What Could Make the Fed Continue Tightening?

Wednesday will be the last rate increase from Federal Reserve policymakers. At least, that is the widespread expectation for the July Fed meeting, as inflation has slumped two-thirds, to 3.0% annually in June, from 9.1% 12 months before. Since March 2022, the central bank has steadily raised its benchmark federal funds rate, now in a band between 5.0% and 5.25%.

But what might convince the Fed that more boosts, at least one at the September meeting, are warranted?

Housing costs. Home prices have begun to rise again, as demand for homes still outpaces the supply, according to Torsten Sløk, chief economist for Apollo Global Management, in a note.

“If housing begins to recover more meaningfully, that raises the risk that inflation is going to be more sticky,” he observed. “The real risk here is—meaning from a markets perspective—that the Fed has to step harder on the brakes.”

Home prices have bounced back after last year’s slide, S&P Corelogic Case-Shiller data indicated. They peaked in June 2022, then gradually began ascending again, rising 1.3% annually in April, the most recent reading.  

Shelter costs, a broader measure than home prices, constitute about 40% of the core Consumer Price Index. Rent increases—and the equivalent housing costs for owned homes—have stayed muted this year. But this is a lagging statistic, with the most recent reading in May. The fear is that higher home purchase prices eventually will lift those rent and rent-equivalent numbers.

While expecting housing inflation to soften up ahead, “a rebound in housing would pose an upside risk to inflation down the road,” warned Dallas Fed President Lorie Logan at a conference earlier this month.

Fed Chair Jerome Powell “will not rule out further action, pointing to the June projections that indicated most members expected more than one hike before year-end would be appropriate,” wrote Michael Gapan, U.S. economist at Bank of America Securities.

The futures market forecasts that the federal funds rate will rise at the July meeting by a quarter percentage point and stay there through year-end. At its June conclave, however, policymakers signaled in their “dot plots” survey that the median benchmark will be 5.6% come December. Getting there would take two more 2023 rate hikes.

On Wednesday, “investors will be watching closely to see if there’s any messaging as to whether a subsequent hike will be announced at the September meeting,” said Stephen Rich, chairman and CEO of Mutual of America Capital Management.