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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The Federal Reserve left interest rates unchanged at is April meeting, but remains on course to boost rates at least twice before the end of this year.

Some analysts had predicted that the sharp decline in the March employment numbers, compounded by the first quarter’s disappointing 0.7 percent increase in economic growth might give the Fed pause. But a stronger than expected April employment report seemed to confirm the Fed’s view that the negative March results were aberrations and did not reflect a downward shift in the economy’s trajectory.

Employers added 211,000 jobs in April, boosting the three-month average to 174,000 and reducing the unemployment rate to 4.4 percent, its lowest level in more than 10 years. In another encouraging sign for the labor market, the broadest unemployment measure, reflecting people who are working part time or have given up hope of finding a job, dropped to 8.6 percent from 8.9 percent in March.

Impressive Momentum

“The momentum in the job market is really impressive,” Jason Furman, chief economic adviser in the Obama Administration, told the New York Times. I’m frankly surprised that this late into an expansion the economy is still adding jobs well above the steady-state pace,” he added.

Recent economic reports haven’t been uniformly positive. Business investment remains restrained and consumer spending increased by only 0.3 percent in March, following back-to-back declines in January and February. A sharp drop in purchases of big-ticket items – especially cars – was primarily to blame, triggering concerns that the boom in automobile sales may be fizzling, after a nearly nine-year run.

Spending has been considerably weaker than consumer confidence would indicate. Although the Conference Board’s confidence index slipped in April, consumers continue to express confidence in the economic outlook, Lynn Franco, the Conference Board’s director of economic indicators, noted. Figuring out why that confidence isn’t reflected in spending patterns “is an exercise that will occupy us for the rest of this year,” Carl Tannenbaum, chief economist at Northern Trust, told the Times.

The housing market, on the other hand, continues to post strong numbers, defying concerns about rising interest rates, rising prices, and shrinking inventories. Existing home sales set their highest pace in a decade in March, rising nearly 6 percent above the year-ago level. Pending sales, a measure of future purchases, declined by nearly 8 percent in March from their February level, in what the National Association of Realtors described as a “slight decline” in momentum.

New home sales also notched their third consecutive monthly gain in March, with an annual sales pace of 621,000 units that beat the year-ago number by more than 15 percent, and blew well past a much more conservative consensus forecast.

The Wrong Direction

Housing starts declined by 7 percent compared with February, which wasn’t what analysts concerned about paltry inventories wanted to see. Although starts were 8 percent higher in the first quarter than in the same period last year, home construction activity is at its lowest level since the Census Bureau began tracking these statistics in 1957, according to an analysis by the Federal Reserve Bank of Kansas City.

Although the inventory of existing homes increased by 5.8 percent in March compared with February, it was still down 6.6 percent year over year. The new home inventory reached its highest level since July of 2009, but the total is still discouraging, representing less than half of what it was in 2006, at the peak of the housing boom.

Home prices, meanwhile continued their upward march in February, rising another 6 percent year-over-year, following a 5.7 percent gain in January, as an increasing number of potential buyers continue to chase an inadequate supply of homes for sale.

Analysts are concerned not only about the mismatch between supply and demand, but also about the increasing gap between the rates at which home prices and incomes are rising. Existing homes prices are 8 percent higher this spring than they were in the spring of 2016, while average wages have increased only a 2.8 during that period.

“So far this year there are no signs that the economy will alleviate the mismatch between incomes and home prices that continues to confound middle-class home buyers in expensive cities," Nela Richardson, chief economist at Redfin, told Housing Wire.

David Berson, chief economist at Nationwide Insurance, quoted in the same article, agreed. The imbalance in overheated, under-inventoried markets “can’t be sustained,” he said. “It can’t go on forever.”