There has been some recent panic in the financial and mortgage markets over the concern that interest rates seem to be headed up. This has happened suddenly and stands in contrast to what I have been saying from the beginning of the pandemic: interest rates will stay low for a very long time. So what changed?
It began when a widely reported metric was released indicating that inflation sped up in April as consumer prices leaped 4.2 percent, the fastest rate since 2008. And core prices, which exclude volatile components such as food and energy, rose 0.9 percent in April from March, the fastest one-month gain since 1981 and significantly more than some economists had expected.
But a handful of the smart economists who I follow had predicted this would happen. We are coming out of an economic shutdown we have never experienced before, and pent-up demand is being unleashed. The constraints in the global supply chain are touching every corner of our lives, from auto repairs to sporting ammunition to designer shoes for the affluent. As of course, within our own industry, a growing shortage of cement in the supply chain is pinching the volumes and revenues of producers in many parts of the country. This imbalance in supply is countered by strong demand, and prices naturally rise.
But I think this inflation bubble is transitory, and inflation will settle down as the workforce stabilizes, subsidies expire, and goods begin flowing normally again. As a result, inflation will return to its tame levels, and so the Federal Reserve will not be forced to raise interest rates to counter any inflationary signs.
Having said that, the Fed has begun to signal an eventual shift away from the easy-money policies implemented during the pandemic as evidence builds of a robust economic recovery. It has been widely reported that the central bank is closely watching economic developments and will be ready to adjust policy when necessary. Minutes from the central bank’s policy meeting in late April indicate that some officials want to begin discussing a plan for reducing the Fed’s massive bond-buying program at a future meeting. The minutes show general agreement among officials on the need to continue supporting the economy with near-zero interest rates and bond purchases. But they also dropped the Fed’s first hint that policy makers could soon begin discussing a slowdown in the pace of Treasury and mortgage-bond purchases, which currently total at least $120 billion a month.
What is key here is they are suggesting that bond purchases will taper, not that they will be raising interest rates. Movements in interest rates as a result of the tapering will be measured in “bips”, or 1/100th of a percent, and will have little impact on prevailing mortgage and commercial bank rates. Fed officials have said for months they think higher inflation this year will be temporary, allowing them to maintain easy-money policies until the labor market more fully recovers from the pandemic, a logic that I agree with. And further, the Fed has repeatedly said it will provide a long runway of guidance before tapering begins.
These current policies are intended to reduce borrowing costs for consumers and businesses to help spur economic growth and a quicker recovery in the labor market, which is 8 million jobs short of its pre-pandemic level. Most importantly, the Fed is attuned to allowing transitory inflation to occur, as otherwise action to restrain inflation at this fragile time could end up significantly constraining the recovery.
I expect tapering of bond purchases to slowly take place over the next year, or more, but there will be resistance by the Fed to increase interest rates despite the threat of inflation, which would affect borrowing costs and could harpoon an otherwise healthy housing market. The Fed knows what they are doing—they will put the economic recovery at the forefront of their policy-making decisions.
Pierre G. Villere serves as president and senior managing partner of Allen-Villere Partners, an investment banking firm with a national practice in the construction materials industry that specializes in mergers & acquisitions. He has a career spanning almost five decades, and volunteers his time to educating the industry as a regular columnist in publications and through presentations at numerous industry events. Contact Pierre via email at [email protected]. Follow him on Twitter – @allenvillere.