The interest rate effect is already showing its first effects on the cooling of demand.
Despite growing doubts among analysts, US Federal Reserve Chairman Jerome Powell is making the difficult bet of a soft landing. In fact, he made it clear on Wednesday that “we are not trying to induce a recession. We are trying to bring inflation down to 2%, [et de conserver] a solid labor market”, according to comments collected by Agence France-Presse (AFP).
In previous meetings, he had already talked about a recession-free inflation target remaining achievable, albeit difficult. And we can sense him giving an inflation bias to the Federal Reserve’s (Fed) dual price stability-employment mandate. He evoked a scenario of fighting against the surge of inflationary fever, foreseeing a rise in unemployment which, moreover, would come to attenuate the upward pressure on wages and, by extension, on prices in the economy.
The Federal Reserve therefore picked up the pace with its 75 basis point hike in the key rate on Wednesday. This is the third increase in a row. The range for the reference rate is moving to 1.5-1.75%, and most officials at the institution see the arrival of a range of 3.25-3.5% by the end of the year, continues AFP. The median forecast projects it at 3.4% at the end of 2022, and at 3.8% in 2023, far from the neutral rate of 2.5% estimated by the Fed. This would not prevent inflation as measured by the personal consumption expenditure (PCE) price index from remaining above the 2% target, around 2.6% the next year and 2.2% in 2024, compared to the 5.2% expected this year.
The Fed wants to calm things down at all costs, avoid unanchoring long-term inflationary expectations and prevent wage inflation from fueling a price-wage spiral.
First effects
But already, the monetary firming initiated since the end of winter is beginning to produce measurable effects. First in the form of a general decline in the main consumer confidence indices. In Canada, the Conference Board index lost 11.7 points in May, to stand at 88.1 points, suffering its largest decline since the start of the pandemic. Now, only 14.8% of respondents believe the time is right to buy durable goods.
In the United States, statistics on retail sales in May, released on Wednesday, show the first monthly decrease since the start of the year, with a decline of 0.3%. And we are talking here about data in current dollars. If we add to this the effect of soaring prices, the contraction in sales in real value would seem to be more pronounced.
“We note that the drop in sales in May occurred mainly in durable goods (cars, furniture, electronic goods and also online stores). This can be seen as an effect of the slowdown in demand in these sectors and also supply problems. However, we must now add the consequences of the marked increase in interest rates. These difficulties should continue over the next few quarters,” writes Francis Généreux, senior economist at Desjardins.
Also in May, analysts observed that supply chain pressures eased in the United States, under the combined effect of improving supply-side dynamics and cooling request. More in detail, Oxford Economics retains an easing of the forces exerted on the prices of certain raw materials last month, which would help to ease the pressure on production costs.
In addition, hiring of workers has remained strong, which, combined with more Americans joining the labor force, would signal that hiring difficulties and upward pressure on wages may have peaked. It’s only been a month, but…
Undoubtedly, the rate effect is measured in the real estate market on both sides of the border. In Canada, the Canadian Real Estate Association indicated on Wednesday that sales of residential properties fell by 21.7% compared to a record month of May 2021, and by 8.6% between April and May. This is the third straight monthly decline. For the period from February to May, the decline reached 23%.
As a result, the average sale price of an existing home fell 3.8%, also posting a third monthly decline in a row. However, these prices are up 3.4% compared to May 2021. For their part, new listings increased by 4.5% compared to April, which reduced the ratio of sales to new registrations at 57.5%. This level is the lowest since April 2019 and is in a balanced market zone, highlights Randall Bartlett, senior director of the Canadian economy at Desjardins.
The downward trend is now well established in Canada, with 75% of markets reporting lower trades. The real estate market remains tight, but based on the ratio of active listings to sales, market conditions eased in almost all provinces during the month. “There are now 3 provinces out of 10 in a balanced territory: British Columbia, Saskatchewan and now Alberta,” pointed out the National Bank economists.
Fingers crossed!