Stock market losses and credit tightening add pressure on Fed

Howard Schneider
| Reuters

Tumbling stock markets and signs of tightening credit may make the Federal Reserve’s job even more difficult this week as U.S. central bank policymakers try to weigh whether consumer spending will suffer as households take stock of the potential blow to their net worth and greater difficulty in obtaining loans.

U.S. retail sales for February, reported on Monday in the last set of hard economic data Fed officials will see before kicking off their two-day policy meeting on Tuesday, were weaker than expected. Some economists saw the slowdown in spending on optional categories like restaurant meals as a signal that consumers across the board – not just lower-income households – were beginning to dial back their purchases.

“Restaurant sales … have been moving sideways to down on a three-month average level in the last couple of months,” analysts from Citi wrote. “This … could suggest some softness more broadly with services consumption. Other discretionary categories like furniture, sporting goods, and apparel were weaker” as consumers spent more on non-discretionary items.

The Fed will release a new policy statement at 2 p.m. EDT (1800 GMT) on Wednesday. Though the central bank is expected to leave its benchmark overnight interest rate unchanged in the 4.25%-4.50% range, it will also issue new economic projections from policymakers that will give an idea of how they feel President Donald Trump’s policies will affect economic growth, inflation and unemployment, and how interest rates may need to change as a result.

A slowdown in consumer spending might raise the Fed’s concerns about growth and make it more inclined to cut rates. But the volatility around Trump’s trade policies, which risk raising prices, has left Fed officials facing the potential quandary of a weaker economy and an acceleration in inflation.

The Atlanta Fed’s GDPNow tracker, updated after the retail sales data, estimates consumer spending in the first quarter may grow by only 0.4% versus a prior estimate of 1.1%.

Adding to an already complex situation is a recent tumble in stock prices that has erased nearly $6 trillion in market value, with the hit spanning individual and institutional investors as well as household retirement accounts.

Tightening conditions

In moments of market volatility, Fed officials will often point out that their job is to maintain stable inflation and maximum employment, not to keep stock prices high.

But stock prices and financial markets in general influence how the broader economy behaves, and in recent weeks the signs have been pointing to tightening credit conditions.

Growth in bank lending has slowed, and the yields on bonds of lower-rated corporations have risen. A Fed index of financial conditions has tightened slightly over the past two months.

In a recent survey by the New York Fed, consumers had a dimmer outlook about the availability of credit, and loan rejection rates have been rising.

“Equities are down … Credit spreads remain tight but have started to widen,” Deutsche Bank economists wrote last week. Unless the administration’s tariff plans shift or markets start to view them differently, Fed rate cuts “may represent the remaining policy lever that could eventually prevent more disruptive moves in financial markets that threaten the growth outlook.”

For consumer spending, the main engine of the U.S. economy, the blow to growth might come if wealthier individuals become cautious after a recent period in which their spending has offset a pullback among less affluent households.

Economists disagree about the degree to which so-called “wealth effects” matter, and many feel that data on unemployment and income are a better predictor of consumption than measures of overall household net worth.

But the speed of the recent drop and the uncertainty about the Trump administration’s ultimate strategy in the current trade war – it has been justified variously as being about re-industrialization, raising government revenue, and part of an anti-drug strategy – have begun to hit consumer and business confidence, with some analysts saying a pullback could follow.

“Retiring baby boomers have accounted for much of the resilience of consumer spending, which was boosted by a very positive wealth effect for many as the value of their homes and stock portfolios appreciated,” Ed Yardeni of Yardeni Research wrote recently. “The risk now is that consumers will retrench.”

Reporting by Howard Schneider; Editing by Dan Burns and Paul Simao

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