Why one rate hike might be too much, according to CFOs

The job market remains tight, but employment is cooling rapidly and job losses are increasing. The yield curve has been flattening a recession, for quite some time already, and the Leading Economic Indicators Index is experiencing one of the worst recessions on record. But the Fed has a one-track mind for now: inflation remains the only focus, and after last week’s PCE price index report showed prices rising again, the Fed will raise interest rates on Wednesday. That’s what the market expects – there was a unanimous belief in this week’s CNBC Fed poll of economists and money managers that a quarter of a percentage point is coming.

But inside the big companies, executives say they see signs of mounting trouble for the economy, and with another rate hike imminent, it may be time for the Fed to pause. That was the tone of a call that CNBC’s CFO Board held Tuesday with chief financial officers from several sectors of the economy. The call, conducted in the background to allow CFOs to speak freely, found CFOs at big companies increasingly concerned about consumer health and the Fed’s narrow focus on fighting inflation as conditions worsened.

One concern CFOs have expressed is that the higher end of the consumer market was masking deeper problems in the economy, with companies tracking the rise in credit delinquencies, and that is now starting to catch on. Pressures in consumer lending, which has risen sharply since May last year, have been concentrated in low-FICO sectors, but a year later, credit weakness is showing up in the core sector, among consumers with higher credit scores as well. Across the FICO bands, there has been a recent 40% to 60% increase in higher levels of delay in installment lending, according to data shared on the CFO call.

As the more prudent lenders operating in the prime space have aggressively backtracked on originations, from credit unions to big players in consumer financial services, non-prime lenders are getting higher FICO credit. While that’s good for them, it also means “we’re definitely heading for a slowdown,” said one CFO. “They’re trying to fight a problem but there’s evidence all over the United States that says the economy is slowing down. Give it time for things to take hold. You just don’t want to keep going in that environment.”

Some prominent voices among former Fed officials have been sending a similar message, including former Boston Fed President Eric Rosengren and former Dallas Fed President Robert Kaplan, who recently said it was time to stop.

Some of the problems CFOs mentioned with the consumer were well known and well tracked for a while already, including consumers backing away from discretionary spending to non-discretionary essentials, and draining stimulus savings of already low-income Americans. But even as inflation in groceries, utilities, and rents eases, and even as the unemployment rate continues to decline, recent data on hours worked shows a decline and that means smaller wage pressures increase. “It’s concerning,” said one CFO.

“I worry about the damage it’s doing,” said another chief financial officer of the Fed’s continued rate hike. “When unemployment comes along, it will go up and down the risk spectrum,” the CFO said, referring to all consumer groups based on FICO scores.

While CFOs said they understand the conundrum the Fed faces because inflation is stubborn, they are equally concerned that the data the Fed is focusing on is “a little bit behind,” one CFO put it. An example is energy prices, which have fallen. “I don’t know if they are [the Fed[ thinking about that. … they’re gonna raise, they’re gonna raise, we can stop that. But I do believe we’re at a point where it’s probably good to pause and see how this plays out over the next three to six months.”

The better-off consumer is also beginning to become more cautious, with evidence of a slowdown in “the discretionary big ticket items,” CFOs said, purchases of over $100.

The slowdown in the consumer is being seen in how much product is moved through the national supply chain, according to CFOs, where softening demand and the freefall in housing, and all of the goods that go into housing, “is really slowing down,” said another CFO. “We’ve been seeing it for a couple of months now.”

“Beyond just inflation and unemployment, there’s a number of other things, whether it’s industrial production, housing, those signs are already there that the economy has moved,” one CFO said.

“There’s a message of cautiousness that I think I’ve heard that this may be the time to pause, and really watch. Otherwise there’ll be a bit of an abrupt stop,” another CFO said.

The Fed is fixated on the employment level, and decided early in this inflation fight that if it is going to break the back of inflation, it has to “break the economy,” and create some level of unemployment, and labor market dislocation. While the labor market remains tight, and the layoffs in tech aren’t representative of the economy as a whole, CFOs said the central bank should be looking forward at this point and putting more focus into how quickly the job market could tip. “I do think there’s a lag on this … and I think they have to be careful not to go too far here,” another CFO said.

“It’s apparent everybody wishes the Fed would stop raising rates,” said another CFO. “I don’t think that’s going to happen primarily because Chairman Powell has said inflation fighting is the No. 1 thing and we as a society and the government and Congress, basically handed the responsibility of managing inflation to the Fed.”

Manufacturing backlogs have doubled over the last year and a half, according to CFOs, and the Fed can solve for the influence that has had on inflation by continuing to raise rates, “basically destroying demand” said one CFO. “So we’re basically forced into the situation. My prediction is by the end of this year, the Fed funds rate will be at 6%. We will be heading into a recession in Q4. And I don’t think they’re going to lower rates, at least until the end of 2024,” the CFO said.”

While traders are betting on rate cuts before year-end, the CNBC Fed Survey shows belief from economists and money managers that the Fed will hold rates higher for eight months.

“We’re headed in the wrong direction, because we only have one tool to use to try to fight inflation,” the CFO who is predicting recession in Q4 said.