Everybody, including the Federal Reserve, is caught in a bind.
You want a strong economy. You want low inflation. The problem right now is this:
While inflation is better than in 2022 when it topped 9%, it is showing signs of resurgence. That may make the Fed reluctant to cut interest rates much in 2024.
There's even a worry the Fed won't start bringing rates down this year. The Fed's key rate is the federal funds rate, which has been at 5.25% to 5% since July 2023.
That was the lesson from the first-quarter Gross Domestic Product report economic report released Thursday by the Commerce Department.
The report showed slowing economic growth overall — an annualized 1.6% — in the first quarter of 2024. But inflation was stronger than expected up to 3.4% from the first quarter of 2023.
That puts the Fed in a bind on interest rates.
The Fed is trapped by growth and inflation
The Fed "is now finding itself caught between a rock and a hard place," wrote Stuart Cole, chief macroeconomist at Equiti Capital in London, in a note to Reuters.
Interest rates surged on the report, and stocks plunged. To understand the Fed's conundrum, remember the Fed is always trying to balance what it describes as its dual mandate.
- Encourage full employment.
- Sustain long-run price stability. In this case, the stated goal is to keep inflation at 2% a year over the longer run.
So, 3.4% inflation, at least as measured by the GDP report is too high. But it is better than it was in June 2022 when the Consumer Price Index showed inflation hitting 9% annualized.
But there's a big "yeah but" to note.
As 2024 opened, many investors and traders were expecting three rate cuts during the year and maybe as many as seven, according to the CME FedWatch Tool.
There was giddy talk that the first cut might come in March. That date has passed, and no one expects a rate cut at the Fed's April 30-May 1 meeting.
Now, the betting is maybe two, with the first in November.
Interest rates are crushing consumers
The inflation worries generated by the GDP report pushed the 10-year Treasury yield up to 4.71% from 4.65% on Wednesday. The 10-year note is a key determinant of mortgage rates.
Freddie Mac's weekly mortgage rate survey, issued Thursday, put the rate on a 30-year mortgage at 7.17%, up from 7.10% a week earlier. Mortgage News Daily, which also tracks the mortgage market, reported quotes of 7.5% as of Thursday.
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For comparison, rates have more than doubled since the summer of 2021, when Freddie Mac's survey showed you could get a mortgage for 3% or lower.
So, a $350,000 mortgage at 3% in 2021 generated a monthly principal-and-interest rate payment of $1,180. At 7.17%, that payment is $1,901, an increase of 61%. (The numbers don't include taxes and insurance.)
Auto loans are running at 7.5% or so for a 5-year loan, up from 4% at the same loan in 2021. On a $25,000 car loan, the payment has jumped from $322 a month to $460.
Car loan payments can swamp a household budget; columnist Dave Ramsey constantly argues one should not buy new cars for that reason.
Let's not even talk about credit card rates. They're sky-high. Wallet Hub says the average credit card rate on new and existing cards is nearly 23% and 22%.
Investors were not happy
The inflation worries — and disappointing earnings reports from Facebook parent Meta Platforms (META) and others — caused stocks to plunge on Thursday's open.
The Dow Jones industrials were off as many as 706 points before losses were trimmed.
The Dow ended the day off 375 points, or 1%. The Standard & Poor's 500 Index dropped 0.5%, and the Nasdaq Composite Index fell 0.6%. (The indexes, however, are still up for the week.)
The iShares 10-to-20-year bond ETF (TLH) was off 0.7% to $87.78. The price for the ETF moves in the opposite direction of interest rates.
The ETF is down 11.2% this year after rising more than 17% after the Federal Reserve Chairman said last fall that the Fed was done raising rates and would likely cut rates this year.
Strong earnings from Microsoft (MSFT) , Google-parent Alphabet (GOOG) after Thursday's market close suggest stocks will get a boost on Friday and may bring interest rates a little relief.
So, too, may another inflation report, the Personal Consumption Expenditures Price Index report for March only. It comes out Friday morning. The consensus estimate is that inflation pressures moderated during the month.
If true, that would cheer skittish investors.
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