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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Since the Federal Reserve boosted interest rates in March, additional rate moves this year have been pretty much a foregone conclusion. That the Federal Open Market Committee (FOMC), the Fed’s policy-making arm, will increase rates at its mid-June meeting remains the consensus view, but the conclusion is somewhat less foregone than it has been.

Mixed economic reports have removed some of the certainty. The May labor market report was particularly cloudy. Employers added 138,000 jobs for the month, disappointing analysts who had expected a gain of 180,000. The Labor Department also revised the estimated gains for March and April downward by a combined total of 66,000 jobs. Wage growth remained tepid, increasing by only 2.5 percent during the past 12 months, underscoring another persistent weak spot in the employment picture.

But the unemployment rate fell to 4.3 percent, the lowest level in 16 years, indicating to some economists that the economy is close to full employment. Other analysts viewed the decline more as cause for concern. The rate dropped “for all the wrong reasons,” one analyst fretted – not because more unemployed workers found jobs, but because more unemployed workers gave up. While the number of people who reported that they have jobs declined by 233,000, the number who classified themselves as either not working or not actively seeking work increased by more than 600,000.

Troubling Mismatch

Another DOL report reflects a troubling mismatch between the jobs available and the skills of the workers seeking employment. According to this report, the number of job openings increased by 259,000 in April, while the number of new hires declined by 253,000.

“Those statistics indicate that labor markets have tightened so much…we may be facing a shortage of qualified workers,” Raymond Stone, an economist at Stone & McCarthy Research Associates, suggested in a note to clients.

Although the FOMC has been signaling its intent to raise interest rates in successive steps this year, committee members expressed varying levels of concern at the March meeting about hints of underlying weakness in the economy. Some viewed the lag in the closely watched inflation gauge, which has remained below the Fed’s 2 percent target, as a signal that policy makers should scale back their rate-adjustment schedule, to avoid a premature move that the economy may not be able to handle.

Strong Notes

The most recent report on consumer spending may allay their concerns. The Commerce Department reported that consumer spending increased by 0.4 percent in April, following an upwardly revised 0.3 percent increase in March. The stronger than expected jump in expenditures, the largest gain since December, adds another positive mark to a list that also includes a 1.2 percent increase in the first quarter economic growth rate – slower than the fourth quarter but stronger than predicted.

Most analysts predict that Fed officials will focus more on signs of strength and less on hints of weakness when they weigh the pros and cons of another rate hike. The weak April employment report “is not enough to derail the Fed at all,” Dan North, chief economist at Euler Hermes – a credit insurer-told the Wall Street journal.

While Fed officials are assuming that strengthening employment will push inflation closer to their target, that irksome lagging inflation indicator could become problematic if it persists. If inflation remains weak, Fed Governor Lael Brainard said in a recent speech, “It may lead me to reassess the expected path of the federal-funds rate in the future, although it is premature to make that call today,”

Housing Inventory Worries

In the housing market, inventory, or the lack of it, remains the primary focus of industry executives and a primary source of concern. The National Association of Realtors (NAR) blamed the dearth of available homes for sale for the larger-than-predicted decline in existing home sales in April and for the continued upward pressure on home prices that is creating a larger barrier to entry for first-time buyers.

“A lack of inventory makes it very challenging for first-time buyers to get into the market," Danielle Hale, NAR's managing director of housing research, told reporters at a press briefing announcing the sales figures. "Price growth is still outpacing income growth, and rents remain quite high,” she noted, “and low supply is hinting at another home-price gain in 2017."

Glen Kelman, CEO of Redfin, used near-apocalyptic terms to describe the impact of shrinking inventory levels, which reached a new low point in April. “It's freaking us out,” he told CNBC. “I think the overall industry for the first time is seeing sales volume really limited by the inventory crunch."

Wrong Direction

New home construction statistics don’t offer much hope for near-term improvement. Builders completed fewer new homes in April than in the previous month, and they started fewer residential projects as well.

"This continued, slow pace of construction of new homes is a major bottleneck to a faster economic and housing recovery," Lawrence Yun, chief economist for the National Association of Realtors, said in a statement

A closer reading of the data yields a somewhat less discouraging assessment of the construction picture. Although completions declined by 8.6 percent in the month to month comparison, they increased by 15.1 percent year over year. And while residential starts declined overall, most of the dip was in the multifamily sector, which analysts had been expecting.

Providing more cause for concern, single-family permits declined by 2.5 percent between March and April – a prime home buying season, when construction activity should be increasing. Some analysts think continued strong demand for homes will ensure that any construction dip is short-lived.

Eyeing the permit decline, Ralph McLaughlin, chief economist for Trulia, told Housing Wire that he isn’t so sure. “We’ll be closely watching this [statistic] in the coming months to see whether the dip is an anomaly or the start of a trend,” he said.