Fed Minutes reinforce softened stance

The Federal Open Market Committee softened its tone in May’s postmeeting statement, a sentiment reinforced within the meeting minutes released Wednesday. Additional rate changes will depend on the lagged effects of monetary tightening on financial and eco

In the post-meeting press conference, Federal Reserve Chair Jerome Powell detailed those conditions and signaled that the central bank will balance inflation risks and a resilient U.S. labor market against fallout from the banking crisis and the potential of a U.S. debt limit breach. Slowing, albeit stubbornly, inflation and stronger economic headwinds make the May hike the Fed’s last for now, though policymakers have left the door open for future adjustments if needed.

May’s minutes again stressed the committee’s confidence in the soundness of U.S. banks. The liquidity crisis that began with the abrupt failure of Silicon Valley Bank and ultimately took down First Republic Bank has eased meaningfully. Lending from the Fed’s emergency facilities has stabilized in recent weeks as deposit outflows from smaller banks have subsided.

This is crucial for the Fed. The central bank’s “separation principle” means the Fed’s lender-of-last-resort activities can be done in isolation from more traditional monetary policy maneuvering. Despite the theoretical commitment to this principle, lending at favorable rates to banks while also working tirelessly to tighten financial conditions was an incongruity that the central bank is happy to see abate. It is difficult to accurately estimate the tightening that banks are undergoing in response to the banking turmoil, but the waning crisis will better allow the Fed to pause and evaluate the economy’s reaction to its restrictive policy and the heightening lending standards at banks.

The Fed is now more likely to overtighten than to do too little, especially as liquidity problems in the banking system could reignite. On the fiscal side, Congress’ failure to raise the debt limit would cause economic fallout beyond the Fed’s ability to contain.

Moody’s Analytics expects the fed funds rate has reached its terminal level for this cycle. Our latest outlook calls for the Fed to start cutting rates in early 2024. Monetary policy will be restrictive through the end of 2025, when the policy rate will return to its neutral rate. We predict that credit conditions will remain tight with the 10-year Treasury yield averaging 3.7% in the second quarter and peaking in the second quarter of 2024 at 4%. We estimate that yields will then decline.

The U.S. market for new homes is improving slowly and April’s sales exceeded expectations. Sales increased 4.1% from March to 683,000 annualized units.

This is almost 12% above the number of new sales in April 2022. The regional sales data are mixed, with the most expensive housing markets—the West and the Northeast— performing worst. Sales of new homes declined 58% in April in the Northeast. Meanwhile, sales in the South and Midwest, where homes are typically more affordable, posted a strong increase in April. April’s reading is further evidence that housing activity is improving.

The modest improvement is consistent with recent NAHB Housing Market Index readings, which show that builders are becoming cautiously optimistic. May’s Housing Market Index was above the 50-point threshold marking good building conditions for the first time since July 2022, pointing to further improvement next month.

Nevertheless, the price of a new home continues to decline, as builders offer steep discounts to keep buyers interested amid higher mortgage rates and buyers shift their search to more affordable homes.

The median price of a new home fell 8% from a year ago, and more affordable homes have become an increasing share of the total number of new homes sold. In April, more than 50% of homes sold cost less than $400,000, compared with one-third last year.