A Token Rate Hike Against a Rising Inflation Tide
The 25 basis point rate hike is trivial. Even a second hike in December is too little too late to stop the inflation train. Inflation is heading a lot higher, and so are interest rates. The Fed likely did not want to raise rates. If it did, it would have done so meetings ago. It was backed into a corner. Kevin Walsh had talked tough about being vigilant and fighting inflation, so with a 90% market probability of a hike priced in, it was put up or shut up. Failing to deliver would have cost credibility. That is why the vote was unanimous - to show a united front when credibility was on the line.
Walsh's claim that the Fed made the decision independently is not believable. At the July meeting the committee agreed inflation remained too high. For more than 5 years inflation has run above target.
The real cause of the inflation problem is deficit spending by the US government under both Democrats and Republicans, which the Federal Reserve has monetized. Inflation has been too high for too long, and interest rates have been too low for too long. That is not a coincidence - they go hand in hand, and both are headed much higher.
The Prime Rate Feeds Straight Into Household Bills
JP Morgan (JPM) became the first bank to raise its prime rate to 7%, a 25 basis point move. The prime rate follows the policy rate in lock step. It shows up directly in bills - many credit card rates, some mortgage rates, and a lot of borrowing costs are tied to it, so they are all heading higher. Walsh signaled no stopping rule: he described inflation as a problem and financial conditions as still accommodative, which sounds like a committee that will keep raising rates. That means American consumers will pay more in interest.
A rate hike is meant to cool demand, yet households face higher borrowing costs before inflation is actually beaten. Higher prime rates quickly reach cards, mortgages, and business loans, squeezing cash flow.
A Bond Bear Market Just Getting Started
Bonds are in a major bear market. A 40-year bull market ran from 1980 to 2020, when the 10-year Treasury yield fell from 16% to under 1%. That reversed 6 years ago. Rates are still low by historical standards - 5% on a 10-year is cheap, especially with the US $40 trillion in debt.
After an early rally that pushed yields lower, bonds sold off. The 10-year Treasury yield is back above 5%, at 5.02%, and heading higher. This is not the top. It is a stepping stone to 6% and beyond. Everything gets more expensive to borrow, not just for the federal government but for everyone. The bond market's rejection of that early rally may matter more than the hike itself - investors are demanding higher yields even as tighter policy is presented as an inflation response.
The bond market vigilantes will only back off if they believe a tough enforcer is guarding against inflation. A quarter point hike is a mamby-pamby, too little too late move that will not convince them.
Mortgages Toward 8%, Then Double Digits
The 30-year fixed mortgage rate has topped 7%. A year ago in September it was 6.3%; this past January it was 6.1%, then 6.1% again. It now sits near 7.25%. By early next year, possibly Q1, it could reach 8%, possibly sooner. The last time US mortgages had an 8 handle was the year 2000 - 26 years ago - so 8% would mark a 27-year high. Mortgage rates will not stop at 8%. They are heading into double digits, above 10%. How high they ultimately go is unknown, but a lot higher.
Since 2000 the median home price has tripled. Because a mortgage payment is almost all interest, the monthly payment has roughly tripled too. The cost to buy a home has tripled - more than double the official CPI rise over the same 26 years.
Affordability Is Worse Than the Numbers Show
An 8% mortgage today is far heavier than an 8% mortgage in 2000. Back then, at the top of the stock market bubble, many people held large stock market wealth, more than now. That is partly why mortgage rates fell - the Fed cut rates after the tech wreck and the dot-com bust. Before that burst, Americans were flush. In the late 1990s the US government was barely borrowing, running the Clinton surpluses. Those were partly accounting gimmicks, but the federal budget was in far better shape, so consumers could afford 8% mortgages.
Today people are broke and struggling with food, energy, insurance, and medical care costs that have all risen sharply. There is no way they can carry an 8% mortgage, let alone double digits. That is why home builders got beaten up in the market and financials are under pressure - rising rates will hit them hard. Even if mortgage rates only match past levels, affordability does not, because home prices are far higher and recurring costs are heavier.
Fiscal Policy Cannot Be Walled Off
Walsh insisted the Fed must stay in its lane, meaning monetary policy, and cannot veer into fiscal policy because that belongs to Congress and the president. That is nonsense. Fiscal policy is central to inflation. Running deficits - spending more than the government collects in taxes - injects demand into the economy. That is stimulative and inflationary, and it works against what the Fed is doing.
You cannot fight inflation without getting fiscal policy under control, unless you are willing to crash the economy with dramatic rate increases and refuse to monetize any debt. The Fed would have to tell the government that if it sells bonds, the Fed will not buy them, forcing it to find private-sector buyers. But the Fed will monetize whatever debt the government creates.
Paul Volcker understood there was no dividing line. He was a sharp critic of the deficits of his day, which were tiny compared to today's, and knew spending had to be reined in alongside monetary policy. The Fed is supposed to be independent precisely so it can criticize fiscal policy without fear of being fired. If the Fed is not free to criticize fiscal policy, it has no real independence. Walsh and his predecessors singing this "not our lane" tune have done the institution and the country a disservice.
Policy Was Never Restrictive, Only Less Accommodative
For years the Fed called its policy restrictive. It never was - it was always accommodative, just less so after hikes than before. Even with higher rates, spending did not fall and savings did not rise. Rates were never high enough to change behavior. The government did not cut spending, and consumers and businesses did not stop borrowing, because borrowing never got too expensive. So the Fed was never restrictive.
Now the Fed finally admits its policy has been accommodative. Walsh described the hike as "removing some of the accommodation" - which means it was never restrictive to begin with. Despite the hike, policy is arguably more accommodative now, because over recent meetings inflation has risen more than the quarter point. Year-over-year inflation will soon carry a four handle, yet officials still talk about 2% and claim progress they are not making. The real test is not the headline rate but whether borrowing, spending, and investment actually change enough to suppress demand.
Real Prices Are Soaring While the Fed Cites 2%
Prices are climbing across the board. Diesel is near $6.15 at record highs. Oil sits comfortably above $100 a barrel - it fell about $3 to $3.50 to trade at $102 after being over $105 the day before, with no end in sight. Fertilizer and other food- and energy-linked goods are also getting much more expensive. There is no way inflation falls.
Markets sold off. The Dow was positive before the hike and closed down about 600 points; intraday it was down nearly 850. Gold rose about $60 an ounce before the hike, then sold off to negative $40 - a swing of about $100 - and settled about $30 lower on the day. Financials fell, with the SPDR XLF financial ETF down 2.5%.
Another Crisis, Worse Than 2008
The housing market is already a bigger bubble than the one that popped in 2008. Home prices must eventually collapse, which might revive sales, but until then mortgage rates keep rising. The Fed will keep hiking for a while but will not hike enough to slow inflation.
Another financial crisis is around the corner, and this time it could be far more catastrophic - it may end up as a sovereign debt and currency crisis, which is much worse. It also means no bailouts. American real estate carries enormous leverage built up over decades of falling yields. If Treasury yields climb further, mortgage affordability worsens even without a dramatic shock, and housing weakness spills simultaneously into banks, builders, and consumer spending.
