In leaving rates alone, the Fed hides behind solid labor market

The Federal Reserve didn’t raise or cut interest rates today, but the meeting highlighted something I have been emphasizing since 2022: the Fed is shaping its policy around the labor market more than inflation.

Both times when mortgage rates fell without Fed rate cuts (in late 2022-early 2023 and in mid-2024), it was primarily due to the economic and labor scares. However, the Fed only cut rates when they believed the labor market was softening in the second half of 2024. For me, the Fed needs to see the labor market break before they pivot to push rates lower.

One talking point today was when Chairman Powell discussed the low hire rate, noting that increasing layoffs could push the unemployment rate higher more quickly. The Fed kept its target unemployment rate at 4.3%, leaving a low bar so that if the labor market breaks, the market knows that the 10-year yield should go lower. | believe the Fed did this on purpose to give themselves a low bar for the markets to work off.

With the loss of manufacturing jobs in 2024, private sector payroll growth is at risk if the next interest rate sector breaks, particularly residential construction jobs. As we can see in the chart below, with housing permits at recession levels, this sector is at risk if mortgage rates keep heading higher.

I recently wrote about the new home sales report, discussing why this report was disappointing, even though the headline beat estimates. As we can see in the chart below, completed units are rolling over while the new home sales market is building up more supply. This explains why housing permits are at recession levels.

Overall, it wasn’t a very exciting Fed meeting or press event, but it touched on some of the key points for the housing market. Fed Chairman Powell noted housing has stabilized since their last meeting, but believes higher rates will cause housing to pull back. The 10-year yield rose after the Fed press release but then moderated a few basis points. It’s currently at 4.56% as I write this.

Jobs week is coming up and as always, labor over inflation still rules the day. Tomorrow we will get the jobless claims report and we will get a fresh batch of labor data next week.