A quick note on the dilemma the Fed faces as markets respond with unprecedented swiftness to shifting expectations about the path of interest rates.

To bring down inflation, the traditional monetary transmission story states, the Fed needs yields to rise along the curve, raising discount rates and financing rates for durable goods purchases like cars or houses, and eventually feeding through to the rest of the economy.

As yields have risen since March, it appears some markets (housing, cars) are starting to respond. As we discussed in last week’s post, our New Vehicle CPI exhibited a fascinating sensitivity to movements in 5-year Treasuries in June and July—the maturity of auto loans is generally around 5 years.

As the figure shows, Dotdat’s real-time New Vehicle CPI fell (off a cliff, on left y-axis) as yields spiked to 3 and then 3.5 percent in mid June (on right y-axis). This collapse also followed an unexpectedly weak preliminary number for Michigan’s Consumer Sentiment measure on June 10th.

As yields pulled back below 3 percent in the second half of July, the real-time New Vehicle CPI stabilized—with its average price level no longer falling, but also not back to the positive trend of April and May. We didn’t see this pattern across any of the other ~ 400 expenditure level items we track.

One advantage of the real-time data is that it enables one to observe goods markets’ dynamic responses to mini regime shifts in interest rates and, at present, how transient that response appears to be.

While the Fed needs yields to rise to slow consumption growth, the almost mechanical part of monetary policy, since 2009, it has also leaned heavily on the policy tool of guiding markets forward—communicating about the future path of interest rates in light of its reaction function, etc.

The current dilemma comes into focus when the bond market gets too far ahead of the rising rate regime the Fed wants everyone focused on now. Extrapolating from the Fed’s reaction function, it anticipates the next phase of the cycle (a slowdown or recession) in which yields revert, as they have since mid July. In turn, the resilience of financing markets and durable goods consumption seems fairly intact following these mini episodes of heightened interest rate volatility.

It will be interesting to see how the Fed manages this knife-edge responsiveness of financial and goods markets in the months to come. We’ll continue to post real-time CPIs for any durable goods sectors with elastic responses to rising (or, depending on the week, falling) yields.

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