Zacks Investment Management

In the latest edition of Steady Investor, we explore market updates and essential points for investors to keep in mind, such as:

• The Federal Reserve pauses rate hikes
• The cost of rent is falling fast
• Saudi Arabia announces oil production cuts

The Federal Reserve Pauses Rate Hikes, But Signals More Tightening Ahead – Starting in March 2022, the Federal Reserve raised interest rates at every meeting, pushing the benchmark Fed funds rate up by 5% in 10 meetings. The pace of monetary tightening was the fastest the U.S. has seen since the 1980s, when inflation was running at double-digits. At the latest June meeting, the Fed decided that it was appropriate to take a pause, leaving the fed funds rate at 5% to 5.25% and agreeing to monitor economic data over the coming weeks to see if inflation and economic activity continue cooling. Earlier in the week, the Labor Department reported that inflation, as measured by the consumer-price index, had risen by 4% year-over-year in May. This was a significant decline from April’s 4.9% increase, and well below the peak of 9.1% reached last June (see chart below). But it also still doubles the Fed’s target of 2%, which is partly why Fed Chairman Jerome Powell signaled that more hikes could come in 2023 following this June pause. Indeed, the Fed released projections for the Fed funds rate for the remainder of 2023, and 12 of 18 officials indicated that rates would need to rise to 5.5% to 5.75% or even higher, if the economy continues growing at its current clip. These projections imply two or three more rate hikes in 2023, which is higher than just about anyone – including this publication – had expected for the year. Just a few months ago, in March, a majority of officials had projected that no additional increases would be needed in 2023, but a stubbornly strong labor market and economy have shifted their thinking.¹

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Year-over-Year Change in Consumer Price Index (Inflation)

Source: Federal Reserve Bank of St. Louis³

Rents are Falling Fast, Good News for Households and Inflation – As we’ve written in this space before, housing is a major component of the consumer price index, and its contributions to date have been negative – i.e., high housing costs are putting upward pressure on the inflation print. We’ve also written that actual changes to rents work on a lag, since both new and existing leases are factored into the inflation reading. The chart below shows how rent CPI has lagged trends in overall CPI:

Source: Federal Reserve Bank of St. Louis⁴

A look under the hood reveals that apartment rent growth has been declining at a much faster pace, however. The average of six national rent-price measures from property data companies indicates that rents for new leases rose less than 2% for the year ending in May, which marks a plummet from the double-digit increases last year. In the coming months, this rapid decline in rent growth will factor into the CPI reading, which should pull inflation down even further towards the Fed’s goal – assuming other goods and services prices continue trending in the same direction.

Saudi Arabia Announces Oil Production Cuts, But Prices Move the Other Way – Another key factor for U.S. inflation is energy prices – namely the prices Americans pay at the pump. It follows that oil markets are the major determinant of energy inflation, which can make news of production cuts from the world’s second-largest oil producer seem counter-productive. But in this case, it hasn’t been – Saudi Arabia last week announced it would cut oil production by 1 million barrels a day in July, on top of previously announced cuts earlier in the year. Crude oil prices fell on the news, and are now hovering around 2023 lows⁵:

Global Price of Brent Crude Oil

Source: Federal Reserve Bank of St. Louis

The Saudis pushed for production cuts because they want to see upward pressure on prices, but they got the opposite. Why? For one, oil production is global, with the U.S. as the world’s top producer. More Russian and African oil has also made its way into the market than expected in 2023, which has kept downward pressure on prices. There are also demand forces, i.e., the fact that global economic growth has been very modest so far in 2023, with the eurozone sliding into a recession and China’s post-zero-Covid recovery faltering. Demand from the U.S. has remained firm, but rising interest rates and the possibility of additional credit tightening later in the year are expected to produce a slowdown.

Three Steps to Overcoming Investor Bias – News and headlines like the ones above may cause you to worry about what’s next for the market, but I recommend making decisions based on data, instead of emotional attachment.

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