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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Color the May employment report disappointing, with a capital ‘D’. Rising unemployment claims had indicated that all might not be well in the labor market, but no one predicted the dismal numbers the Department of Labor reported: Employers added only 69,000 jobs in May – well below the far from robust gain of 158,000 the consensus forecast had projected. The unemployment rate increased slightly – to 8.2 percent from 8.1 percent – and, adding statistical insult to injury, the lackluster April gain of 115,000 jobs was revised downward to 77,000.

In other disturbing signs, the “underemployment rate” – reflecting part-time workers who would prefer to be working full-time and those who want jobs but have given up on finding them – increased from 14.5 percent to 14.8 percent. The number of workers unemployed for 27 weeks or more rose to nearly 43 percent of all jobless workers from 41.3 percent in April as the average unemployment period increased to 39.7 weeks from 39.1 – an 8-month high.

Before the May report, the forecast winds seemed to be blowing more optimistically, as analysts had largely dismissed the April labor report as a temporary interruption of an improving employment trend. The National Association of Business Economists, for example, was predicting that monthly employment gains would average close to 190,000 for the rest of this year.

Fed Caution

But Federal Reserve Chairman Ben Bernanke and the Federal Open Market Committee (FOMC), the Fed’s policy-making arm, have consistently cautioned against an overly enthusiastic interpretation of this year’s heretofore improving employment reports.

In the minutes of the committee’s April meeting, several member expressed concern that the “downside risks” in the consensus economic forecast could increase enough to warrant further Fed intervention. Bernanke, meanwhile has pointedly warned that the failure of Congress to agree on a budget – and the legislative saber-rattling surrounding that discussion – could tip the economy back into recession.

Against this backdrop of anemic job creation and gathering clouds – mainly, although not exclusively, in Europe that threaten the economic recovery here – the housing market, uncharacteristically, has provided a few rays of light.

The 5.5 percent decline in pending sales recorded in April – the steepest decline in this National Association of Realtors (NAR) index in more than a year – suggests some cause for future concern. But the index is still nearly 15 percent higher year-over-year. And other housing indicators have been encouraging.

Encouraging Signs

New home sales increased by 3.3 percent in April and the inventory of homes for sale (depleted, to be sure, by a dearth of construction activity) fell to a 5.1 month supply – encouragingly below the six-month supply defined as a “balanced” market.

New home starts increased by 2.6 percent – a stronger-than-expected performance, but building permits (an indicator of future sales) fell by nearly 7 percent compared with March. Most of that decline was in the volatile multi-family sector, however; single family permits actually increased slightly, (by almost 2 percent) as did builder confidence, measured by the National Association of Home Builders/Wells Fargo index, which hit a five-year high.

“We’re at a point where we see more light and less tunnel,” Michael Gapen, a senior economist at Barclays Capita, told Bloomberg News. “Residential construction is no longer a drag on the economy and will contribute to growth.”

Signs of Life

Analysts also saw welcome sighs of light – and life – in the existing home sector, where sales increased by 3.4 percent in April following two months of declines. The annual sales pace of 4.62 million units was the highest level since May of 2010. Although inventories increased – to a 6.6 month supply – that, too, was characterized as a positive sign – evidence that optimistic owners were putting their homes on the market in anticipation of a strong spring buying season.

Encouraged by these improving numbers, the NAR has revised its sales forecast for the year upward – to 4.66 million from 4.26 million in 2011 and up again to 4.92 million for 2013. Industry executives are also sounding much more upbeat.

“We are feeling better than we have at any time in the past five years,” Robert Toll, chairman of Toll Brothers, Inc., told analysts on a recent earnings call. More evidence is needed before pronouncing the recovery fully in place, he admitted. “Nonetheless, it sure feels good compared to the desert we’ve just crossed.”

Finding the Bottom

Industry analysts have been particularly encouraged by improvements in home prices. Median prices increased for both new and existing home sold in April – by nearly 5 percent and 10 percent, respectively, compared with the same month last year. Several other indexes have indicated similarly that the dizzying price decline may have ended. The closely-watched Case-Shiller index fell by 2.6 percent in April – the smallest year-over-year dip since December of 2010, while the Federal Housing Finance Agency recorded a 3 percent annual increase in March – the largest year-over-year gain since November of 2006.

Some analysts think prices have hit bottom, while others think the floor is “in sight” – close, but not quite there yet. Most agree generally with Stan Humprhies, chief economist for Zillow, that the housing market is at least “moving in the right direction.”

But the pace, strength and sustainability of the housing recovery will be determined by an economic outlook that has become less certain in the past two months. Unless the labor market improves markedly, the housing recovery, to the extent that there is one, will remain fragile. And if economic growth stalls, as some analysts now think may be more likely than not – you don’t need an economics degree or a crystal ball to predict what that will mean for housing.