Inflation Pressures Are Easing but Rate Cut Forecast Remains Uncertain

The New Year is beginning where the old one ended -- with uncertainty about when – or whether – the Federal Reserve will begin cutting interest rates.

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Employers added 175,000 workers to their payrolls in February, surprising analysts, braced for a much weaker report, mirroring the weakness reflected in several key sectors, including retail sales, consumer spending and housing. Revisions in the Department of Labor data also increased the December and January employment totals by about 25,000.

“The fundamentals are good,” Joe LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. told Bloomberg News. “Faster job growth means faster income and more discretionary spending. Ultimately, with more business spending, not only will they hire more people, they’ll hire more capital. Everything becomes self-reinforcing.”

Before the better-than expected employment report, the savage winter weather had been taking the default blame for a growing consensus that the first quarter of this year would be weaker than predicted, producing headlines such as these: “Three signs the economy is in a quagmire,” and “more signs the economy will stink.” These negative indicators included, among others: three consecutive monthly declines in retail sales, a 1 percent dip in factory orders for January, and sluggish consumer spending rates.

GDP for the fourth quarter was also revised down from the 3.2 percent initially reported to 2.4 percent. A miniscule (0.3 percent) increase in the Leading Economic Indicators for January exacerbated concerns that the weather alone might not explain the declines in some sectors and the weakness in others. The strong January labor report, gains in consumer confidence, household net worth and a small rise in business investment weren’t enough to dispel the growing unease about the outlook for this year.

Not Strong Enough

“If the economy is going to move on to a faster track in 2014 compared to last year, consumer demand and especially investment will need to pick up significantly from their current trends,” Ken Goldstein, a Conference Board economist, told MarketWatch.

More optimistic analysts (and there are some) got no help from housing market reports indicating that this sector isn’t likely to be the source of economic strength it was last year.

Existing home sales fell by 5.1 percent in January – both month-to-month and year-over year, sinking to their lowest level in 18 months. Pending sales were flat, 9 percent lower than a year-ago, at their lowest level in more than two years.

Lawrence Yun, the NAR’s chief economist, didn’t blame the weather, at least not entirely, for the negative numbers. While it was a factor, he agreed, was among the few analysts not pointing fingers at the weather. While it was a factor, he agreed, “We can’t ignore the ongoing headwinds of tight credit, limited inventory, higher prices and higher mortgage interest rates,” Yun noted in a press statement.

Steep increases in flood insurance premiums were also problematic in some markets, responsible for derailing nearly 40,000 home sales in the past three months, according to NAR estimates.

Not Filling the Gap

Also reflecting weakness in housing demand, mortgage originations have fallen by nearly 40 percent over the past year, reaching their lowest level in five years in the fourth quarter, as purchase mortgage volume has not filled the gap created by declines in refinancing activity.

“This is the time of year we would expect a significant pickup in purchase activity, and we are not yet seeing it,” Mike Fratantoni, chief economist for the Mortgage Bankers Association, said in a statement.

Rising appreciation rates have improved the negative equity picture, but not enough to make a significant dent in inventory levels by enabling large numbers of underwater buyers to sell their homes. More than 13 percent of mortgage holders still have negative equity, and 21 percent of them have equity of less than 20 percent, making it difficult for them to sell, according to data compiled by CoreLogic. Another 10 million homeowners have equity of less than 5 percent, putting them at “high risk” for slipping back into negative equity territory, the CoreLogic report warned.

Tight inventory levels, meanwhile, are stirring concerns of a repeat of the bidding wars and steep almost bubble-like price increases that roiled some markets last year. Inventories of for sale homes in February represented a 4.9 months’ supply, up slightly from 4.6 months in January and 7 percent above the year-ago level, but still well below the 6.6 -6.5 months’ supply viewed as a balanced market.

No Help from New Construction

A surge in new home construction would solve both problems, the NAR’s Yun has pointed out, increasing inventories and easing upward pressure on prices. But relief from that direction doesn’t appear imminent.

New home starts in January fell 16 percent below the December level and percent below the year-ago figure, while single-family permits fell by 1.3 percent.

Undeterred by those numbers, if not entirely unconcerned by them, industry executives blamed (guess what) the weather, insisting that the decline was a pause, not a problem. Even with the negative turn, housing production levels for the further quarter were above the one-million-mark for the first time since 2008, David Crowe, the NAHB’s chief economist, pointed out in a report, “The less weather sensitive permits data suggest that our forecast for solid growth in single-family housing production in 2014 remains on track, as pent-up housing demand is unleashed.”

New home sales for January provided some support for that view. Sales volume was nearly 10 percent higher than the same month a year ago, surprising analysts, who had predicted a decline of just about that amount. Buoyed by those numbers, the strongest in nearly six years, some economists are now predicting that new home sales could increase by more than 20 percent this year. Those upbeat predictions are based on assumptions (or hopes) that employment growth will strengthen, that interest rates won’t rise much, even as the Fed tapers its bond purchases, and that home prices will increase enough to encourage owners to sell, but not enough to create affordability problems for buyers.

Price Trends

Appreciation rates have slowed somewhat this year after rising more than 13 percent last year on the Case-Shiller 20-city index – the largest year-over-year gain in eight years. Readings for December and January, and a quarterly reading that was “nearly flat,” suggest “a loss of momentum,” David Blitzer, chairman of this index committee for the Standard & Poor’s Dow Jones Indices, said in a recent report. The price trend, combined with the recent declines in both home sales and new construction activity, suggest “a bleaker picture” for housing, Blitzer cautioned.

A different price index, published by CoreLogic, shows that prices continued to increase in January, putting average prices in 22 states now at or within 10 percent of their pre-market-meltdown levels.

“Polar vortices and a string of snow storms did not manage to weaken house price appreciation in January,” Mark Fleming, chief economist for CoreLogic, said in a company report. “The last time January month-over-month and year-over-year price appreciation was this strong was at the height of the housing bubble in 2006,” he noted, although he didn’t indicate whether he considered that an indication of strength or cause for alarm.

CoreLogic’s relatively positive view of home prices isn’t widely shared. And Alex Villacorta, vice president of research and analytics at Clear Capital, thinks current trends suggest cause for concern. “Our early data shows national quarterly price gains are falling at a rapid pace and told DS News.

A recent increase in distressed sales provides another cause for concern, Villacorta believes. Although distress sales often increase during the winter, he acknowledged, the trend could be problematic now, because investor demand (which has prevented those properties from glutting the market and eroding price gains) has ebbed. “If we don’t see a correction come spring,” Villacorta cautions, “the housing market may be in for a long year.”