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Fed’s High Wire Inflation Fighting Effort Risks Triggering a Recessionary Fall

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Published: 10 May 2022

Imagine a high-wire act performed without a net.  That describes the Federal Reserve’s effort to curb inflation without crashing the economy.  Success will bring applause and relief; failure, a brief downturn, at best, with a prolonged recession the worst case outcome. 

The Fed took its second definitive step along that tremulous wire in May, by approving a half-percent increase in its target Fed Funds rate. This followed the quarter-point hike in March that had brought the rate above zero for the first time in two years.   

Underscoring the Central Bank’s determination to tame an inflation rate (8.5 percent) that has reached a 40-year high, Fed Chairman Jerome Powell acknowledged the impact of rising prices on consumers and businesses. 

“We understand the hardship it is causing,” he told reporters, “and we’re moving expeditiously to bring it back down. We have both the tools we need and the resolve that it will take to restore price stability,” he added.

 

Success ‘Unlikely”

Achieving the soft landing the Fed hopes to steer won’t be easy, Powell noted.  Most analysts don’t think it will be possible.   Fifty seven percent of the economists responding to a recent poll said the Fed’s efforts will produce a recession compared with 33 percent who think that outcome can be avoided.

 “The likelihood is that things will be worse and last longer than in most models, meaning that the Fed’s ability to fashion a soft landing is highly unlikely. If it happens, it will be through sheer luck only,” Joel Naroff of Naroff Economics wrote in a note to clients. 

Responding to the Fed’s rate hikes, and anticipating more to come, mortgage rates have been rising for several weeks, now exceeding 5 percent for the first time in a decade.  Mortgage applications have been declining, as a result.  Prospective buyers, struggling to keep purchase costs within an affordable range, have begun turning to adjustable rate mortgages.  The Mortgage Bankers Association (MBA) reports  that ARMs represented nearly 10 percent of applications processed in early May, which doesn’t sound like a lot, but it is double the number reported just three months ago.

The combined impact of rising mortgage rates and rising prices (up almost 20 percent year-over-year in the February S&P CoreLogic Case-Shiller National Home Price Index) are exacerbating the affordability strains that many buyers were already feeling.

Affordability Strains

First American’s  Real House Price Index increased by more than 30 percent in February. That’s the largest  jump in this barometer’s 30-year history, and it has reduced the home purchasing power of consumers by almost 7 percent over the past year. Buyers purchasing a median-priced home with a 30-year loan are paying $550 per month more today than they would have paid for the same home a year ago, according to Realtor.com

Given those statistics, it is hardly surprising that  buyers are feeling less optimistic about the home ownership outlook. Fannie Mae’s Home Purchase Sentiment Index for March fell by 2.1 points to 73.2, as only 24 percent of respondents said this is “a good time to buy,” a record low for that component.  A Gallup survey reported similar results:  Only 30 percent of respondents agreed that  it’s a good time to buy a home, down 23 percent from a year ago and the first time the share has fallen below 50 percent since the poll began in 1978.

 “If consumer pessimism toward homebuying conditions continues and the recent mortgage rate increases are sustained, then we expect to see an even greater cooling of the housing market than previously forecast,”  Doug Duncan, Fannie’s chief economist, wrote in an analysis of the survey results.   

Signs of Cooling

Analysts agree that rising rates haven’t yet hit the housing market with hurricane force – but the winds are evident in current reports.  Existing home sales, new home sales and pending sales all declined in March, as did new single family home construction starts and permits for new construction.

Although prices are still rising, the rate of increase appears to be slowing – and sellers are beginning to respond.  Redfin reported price declines in the asking prices for 12 percent of its listings in early April, and that rate is increasing, Daryl Fairweather, Redfin’s chief economist, noted in a recent analysis.

“Price drops are still rare, but the fact that they are becoming more frequent is one clear sign that the housing market is cooling,” he said, illustrating “that there’s a limit to sellers’ power. There is still way more demand than supply, and buyers are still sweating,” he added, “but sellers can no longer overprice their home and still expect buyers to clamor at their door.”

In another sign that an overheated market has begun to cool, Redfin reports that fewer homes are receiving competing bids, a trend that Fairweather expects to continue as rising rates price more buyers out of the market. 

“That should provide some relief for people who can still afford to buy, as they’ll likely face fewer competing offers and may no longer need to offer drastically over the asking price in order to win,” he noted in a recent  report. “Unfortunately, the slowdown in competition won’t help those who have already been priced out of homeownership and are now grappling with soaring rental costs.”     

Rising Inflation Is Bringing Consumers Down

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Published: 20 December 2021

The unemployment rate is falling, job openings abound, wages are rising, the housing market is booming – and consumers feel miserable.  That’s the takeaway from October data reflecting a sharp dichotomy between how the economy is doing (reasonably well)) and how consumers are feeling about it – not well at all.

More than 70 percent of the consumers responding to Fannie Mae’s November National Housing Survey said the economy is on the “wrong track,” a 5 point month-over month increase and the most negative view this survey has found in the past decade.

The University of Michigan’s consumer sentiment survey, similarly, plummeted in November to depths last seen when the economy was struggling to emerge from the ‘Great Recession’ of 2007-2009.

For increasingly gloomy consumers, inflation is the major source of discontent.  The survey noted “the growing belief among consumers that no effective policies have yet been developed to reduce the damage from surging inflation.” Consumer prices increased 6.2 percent year over year in October, the steepest jump in more than 30 years. 

Some analysts contend that excessive stimulus – pandemic assistance payments from the government and Fed policies that have kept interest rates low – are to blame.  Others argue that the pandemic has triggered temporary problems – outsized demand, delivery bottlenecks, and supply shortages – that will self-correct as the pandemic wanes.   

Fed’s Dilemma

This creates a dilemma for the fed – which has to walk a fine line between keeping inflationary forces from getting out of hand and avoiding moves (raising interest rates) that would short-circuit a still strong recovery and might tip the economy into a recession.

After holding firmly to the belief that inflationary pressures would prove transitory, Federal Reserve Chairman Jerome Powell acknowledged that the pressures were proving less transitory than Fed analysts had expected. In recent Congressional testimony, he explained: :  “What’s happened—and we’re very, very straightforward about it—is that inflation has come in higher than expected, and bottlenecks have been more persistent and more prevalent….We see that just like everybody else does, and we see that they’re now on track to persist well into next year.”

As a result, the Fed may accelerate its schedule for “tapering” purchases of Treasuries and mortgage-backed securities, ending that process by March instead of closer to the end of next year as policy-makers had planned.  Faster tapering would create the option of boosting interest rates sooner if they decide tightening is needed to combat inflation. 

Among the variables the Fed will consider is the evolution of Omnicron – the newest and now rapidly-spreading COVID variant.  The preliminary consensus appears to be that the impact will be less severe than the initial pandemic wave, and so unlikely to alter the Fed’s current policy plans. But analysts acknowledge the consensus is based on what is still an uncertain outlook.

Where does that leave us now, heading into the holidays?  Here’s a brief summary.

 Employment: Signs of Weakness

The economy gained a paltry 210,000 jobs in November – less than half the total analysts were predicting.  The unemployment rate fell to 4.2 percent from 4.6 percent, but the sagging labor force participation rate continued to sag, as unemployed workers  remained far less enthusiastic about  accepting open positions than desperate employers are to fill them.  The job-search site Zip-Recruiter estimates that there are currently 11 million job openings compared with about 7  million unemployed workers who say they are looking for jobs.

“That’s the lowest ratio of unemployed people to job openings we’ve ever seen and that is contributing to unprecedented tightness in the labor market,” Julia Pollak, chief economist for the company, told the Wall Street Journal.

People who have jobs are also leaving them in record numbers. More than 4.4 million workers quit in September, the Labor Department reported.  The quit rate declined slightly in October, but remained in record territory.

“The real problem is… can we get the labor force participation rate to change meaningfully?” Ron Hetrick, a senior labor economist at Emsi Burning Glass, told NBC News.com.  “That is the primary thing holding us back.”

Omnicron remains a key variable in both the employment and the inflation forecasts.  If public health conditions worsen, and or if fear of the virus keeps workers out of the labor market, labor shortages will put upward pressure on wages, possibly triggering the traditional wage-price inflation spiral that we haven’t seen yet but that many analysts fear.   

Housing: More of the Same

The housing market continues to do what it’s been doing all year - -defy predictions that it is going to stumble. Existing homes sold at a seasonally adjusted annual rate of 6.34 million units in September, almost 6 percent below the year-ago pace but well above a consensus forecast anticipating a seasonal slowdown that hasn’t occurred.

Redfin’s Homebuyer Demand Index posted its highest reading in the past four years in November as buyer demand for homes continues to outstrip the supply.

New home sales also beat predictions, managing a 0.4 percent increase over September’s 742,000 rate – revised downward from the initially reported 800,000 units. 

Home starts and permits have increased a little, but inventory levels remain depressed.  The National Association of Realtors (NAR) reported 1.25 million homes available for sale in October, 12 percent fewer than in the same month a year ago.

Home prices, which have been rising steadily, are still increasing, albeit more slowly, but you have to look closely to notice the difference.  The Case-Shiller National Home Index  recorded an annual increase of 19.5 percent in September compared with a 19.8 percent gain in August.  CoreLogic’s Home Price Index jumped by 18 percent year-over-year in October, the largest year-over-year gain since the index was created 45 years ago.

Rising prices, inventory shortages and inflation fears have dampened consumers’ spirits, but, apparently, not their determination to buy homes.  Pending home sales – an indicator of future transactions – increased by 7.5 percent in October, recovering from a 2.3 percent dip in September.  Analysts had expected a recovery, but a smaller one. Lawrence Yun, the NAR’s chief economist says rising rents and fears that mortgage rates will rise, and consumers’ ‘sound financial footing’ are fueling demand. 

"Home sales remain resilient, despite low inventory and increasing affordability challenges," he noted, while "inflationary pressures may have some prospective buyers seeking the protection of a fixed, consistent mortgage payment."  Despite the challenges the pandemic, inflation fears, rising home prices and anemic inventories have created this year, Yun predicts that sales will exceed 6 million, “which will shape up to be the best performance in 15 years.”

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