FOMC will continue to raise interest rates in 2023. (Photo by Mark Wilson/Getty Images)
Americans received positive news yesterday that the rising inflation rate is slowing. The Federal Reserve finally has enough data to make less justification for raising interest rates. I still expect the Federal Open Market Committee to hike rates 50 basis points today, which would be a welcome change from several 75 basis point hikes earlier this year.
Inflation is still a challenge for the Federal Reserve, however, as current consumer price index (CPI) levels are significantly higher than the average rate of 2.1% that had existed in the three years before the pandemic hit. Yesterday, the US Department of Labor announced that CPI rose 7.1% yoy in November. This is less than 7.7% in October. Luckily, inflation has eased since peaking at 9.1% in June.
The inflation rate has slowed but remains well above the previous three years … [+]
Stock investors reacted positively to the CPI numbers. If the CPI continues to trend lower, the stock market will continue to react positively as companies benefit from lower borrowing costs. In addition, bond investors will shift some of their investments into equities as inflationary trends ease.
However, most sectors of the economy are still suffering from the current high-yield environment. Nobody feels this more than people looking for a home. According to Gregg Menell, chief executive officer of Pendulum Property Group, “Higher interest rates, combined with the speed at which they have moved, have exacerbated an already challenging housing market. First-time buyers, who have already faced stiff competition and low affordability due to low inventories, are now hampered by the higher cost of capital.”
Gregg Menell, CEO and Managing Broker, Pendulum Property Group
Menell also explained that “the speed at which interest rates have risen has also thwarted homeowners’ plans to sell, thereby keeping inventories low. Downsizers advise making the move because swapping a 3% mortgage for a 6% mortgage reduces the financial incentive to sell. Similarly, in the face of higher interest rates, the upside buyer finds homes that are out of reach. The cogs of the market feel stuck. Until these homeowners find a financially viable place to live, inventories will likely remain low.” He cited Scarsdale, New York, as an example of the current housing market environment. “We had around 120 houses on the market at this point in 2018. Now we only have 31. Inventory is weak and there is enough demand to keep prices at current levels despite interest rate movements.”
Sectors that are also very vulnerable to the rising rates are broadcasting and media, technology and telecoms. These sectors are heavily leveraged and this leverage combined with the rising interest rate environment will further increase their cost of borrowing.
Sectors with high default rates are most vulnerable to the current high interest rates … [+]
One sector that has benefited greatly from rising interest rates is the banking sector. I also think the outlook for 2023 is positive. Banks’ net interest margins have risen as they now charge more for every type of loan and line of credit they take on. Since their liquidity and capital levels are above minimum requirements, I expect they will be able to pay more dividends to their shareholders.
While raising interest rates may be necessary to curb inflation, the rising cost of borrowing for individuals and businesses will likely push us into or near recession in 2023. If, unfortunately, there is a recession next year, eventually the banking sector will do as well as it did this year.