June 4, 2006

Where are interest rates headed?

With the most recent downturn in the stock market, one has to be wondering whether we are heading into a bear market, and if there will be a Fed policy shift to keeping interest rates steady during the next FOMC meeting in June. In fact, May's monthly performance was the worst in nearly two years:

Dow -1.8%
Nasdaq -6.2%

There are also some other signs that could bode well for an interest rate pause:

• Weaker than expected Employment Report for May
• New hires of 75K versus expectations of 175K
• Hourly earnings rose .1% instead of expected .3%
• Positive note: Unemployment down slightly to 4.6% nationwide
• Pulte Homes (PHM) reported that new orders for April and May were down 22% compared to the same period last year. Of course, higher interest rates, along with higher inventories will impact housing demand.

This past Wednesday, the Fed released the minutes from their May meeting. Obviously, inflation was a major topic of discussion. The members discussed policy options from a rate pause, 25 basis point increase, and even a 50 basis point increase. They of course, settled on a 25 basis point increase.

From the minutes

"Still, it seemed most likely that, with modest further policy action, including a 25 basis point firming today, growth in activity would moderate gradually over coming quarters, pressures on resources would remain limited, and core inflation would stay close to levels experienced over the past year."

Despite some economic cooling, I believe we're in for another 25 basis point increase for the June meeting. It is unlikely in my opinion that the Fed will pause after just one month of economic data. There are aberrations in the data that happen all the time. But it does appear that after 16 straight rate increases, that their work is starting to pay off, and that maybe we will see rates stay flat during the summer months. Which would be good news for the housing and the stock market.