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The Table Is Set for a December Rate Increase

Minutes from the Fed's October meeting suggest a December rate hike, but investors should expect a gradual approach, says Morningstar's Bob Johnson.

The Table Is Set for a December Rate Increase

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. The Fed's minutes from their October meeting show that they're ready to raise rates in December. I'm here with Bob Johnson--he's our director of economic analysis--for his take on this. We'll also look at some recent data. Bob, thanks for joining me.

Bob Johnson: Great to be here today.

Glaser: Let's look at these Fed minutes. Do you think that the table really is set now for rates to increase in just a few weeks now? 

Johnson: I absolutely think it is--obviously, so does most of the rest of the market. The thinking now is there's a probability of more than 70% that rates will be raised after the December meeting. So, there's a pretty strong probability of that. I think the minutes kind of validated what a whole lot of us had been thinking.

Glaser: So, there was nothing too surprising there; but this was, of course, before we got some more recent data--in particular, a strong jobs report. What about inflation? That's one area that we haven't really seen come closer to the target. Did the inflation data this week show that that's going to be a worry? 

Johnson: We'd had a couple of months here and there recently where inflation had actually been down, and there had been some concern about it. But the consumer price index, which came out this week, was up 0.2%, so it was up in the right direction. The year-over-year, three-month moving average of inflation on the core was 1.8%, and total was just about 0.1%. So, we're kind of moving up on the core toward that 2%. And as we lap the big energy price declines last December and January, the whole combined inflation rate is likely to move pretty close to 2% at the beginning of next year, which is right in line with the Fed targets.

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Glaser: So, there's been some worry about inflation being a little bit weak. Another part of the economy that's been a bit of a worry sector is manufacturing. We got industrial production this week. Are there signs of things stabilizing there? 

Johnson: To some, I think the headline number might have been disappointing. It actually showed a small decline in manufacturing month to month of 0.1%, but the reason that number was down so much was primarily related to the utility sector, and the reason the utility sector was down was because we've had one of our warmest Octobers on record. And so that caused utility usage to go down, which factors in the industrial-production calculation. But it really doesn't speak to the health and the employment levels likely going forward. Also, the energy sector itself--namely the drilling and mining sectors--was down modestly, but that's not a huge part of the index. Now, the good news was that manufacturing--minus the energy and utilities stuff--did quite well. We were up 0.4%, which was one of the best percentage performances we've seen recently in that number. And even if you look at the data on a year-over-year basis, we've been at about the 2% year-over-year growth-rate basis now for three or four months. So, we've kind of stabilized that number in manufacturing. I think we had a big fall as we adjusted to a lot of different things and a very strong manufacturing economy in 2014. And in 2015, we started with a bad decline, and I think we've now kind of stabilized the manufacturing sector. So, I don't think it's going to be as big of a detractor as it has been.

Glaser: An area that you've long thought could be a driver of a continued recovery is housing. We got some starts data that looked a little bit weak this week. What's your take on this? 

Johnson: We've had to dig hard behind the headlines this week because none of the headline numbers really told the truth, so to speak--and housing starts is certainly one of them. We had a pretty healthy decline in the number of starts in total from September to October, but almost all of the decline was in the multifamily sector, which is an exceptionally volatile sector, and single family was down very, very modestly. But more important than both of those numbers is the permits data. That data has to do with a house that's eventually going to be built or an apartment that's going to eventually be built, and the permits data has been rock-solid. Certainly, that's some good news going forward, and that's been a more reliable indicator of the health of the economy. Starts data kind of goes up and down with the weather, the funding, and the flavor of the week for tax incentives and so on. Permits have been a little bit more balanced, so we're hopeful that that's a better indicator of what's going on. And certainly, there's been a number of other things that also suggest the housing market is a bit stronger than we might think.

Glaser: And certainly, if you ask the folks at Home Depot (HD), they would say the housing sector looks pretty strong, too. What were some of the other housing indicators we got this week? 

Johnson: Absolutely. And I think the sales that you have at the likes of Home Depot and Lowe's (LOW) are certainly indicators that people are spending money on housing-related things. We've seen housing activity pick up, and usually you see a pickup in things like furniture and remodeling stuff shortly thereafter. It's been a little bit slow in coming, but we certainly saw it in the Home Depot and Lowe's numbers. Also builder sentiment this week, while not quite as strong as it had been at the very peak this summer, we're certainly near recovery highs in terms of builder sentiment. So, believe me, the housing market is alive and well despite the disappointing headline number in housing starts.

Glaser: So, given the minutes this week and then the data that we've gotten since that October meeting, it seems like it would really take some exceptionally poor data to keep the Fed off track at this point.

Johnson: I think, in my mind, it really would. Certainly, in the minutes, one of the things that they indicated is they're worried they're creating more uncertainty in the economy--will they or won't they? They just feel that they should get on with it, and maybe one of the contributors to some of this slowness has been the uncertainty they're creating--they've got people overly focused on that first number. As we've talked about, it shouldn't be the first number that we're focused on; it's the path going forward. And they've certainly indicated in the minutes--yet again--that it'll be a very, very, very gradual approach. And getting this first one out of the way is more about settling people down than making any big difference in anybody's financing costs.

Glaser: Bob, thanks for your analysis today.

Johnson: Thank you for having me today.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.

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