Figure 12-2: The discount or fed funds rate as a leading indicator of real consumer spending (PCE)
It is clear that rising year-over-year Fed-managed discount or fed funds rates (green line, inverted on chart), which make borrowing more costly, have typically led slowing growth in consumer spending (black line). Conversely, falling discount or fed funds rates, which make borrowing easier, have almost always presaged upturns in consumer spending. The leading/lagging relationship between interest rates and consumer spending is remarkably consistent (with the exception of the mid- to late 1980s).
Current Comment: Continuing increases in year-over-year changes in the Fed Funds Rate implemented by the Federal Reserve Board from 2004 through mid 2006 (indicated in the green line; remember the inverted right-hand scale)—foreshadowed a moderate (though less-than-expected) slowing of year-over-year growth in consumer spending in late 2005 and 2006. This slowdown, as previously noted, however, was not of a sufficient degree to cause a bear market. Due to the Fed’s recent pulling back from further Fed Funds Rate increases, the year-over-year rate of change in interest rates is actually improving at this time.
