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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An increasingly  jittery public, anxious for some good news, got a solid dose of it in the December employment report:  Employers added 312,000 workers to their payrolls for the month, blowing well past the 182,000 jobs analysts were predicting, and extending the steak of consecutive monthly job gains to 98 months - -the longest on record. 

Employment totals for October and November were both revised upward by a combined total of 58,000, boosting payroll growth for the year to 2.6 million – the most  since 2015.  Wages increased by 3.2 percent, equaling the October gain, which was the best since April 2009.

The unemployment rate inched up to 3.9 percent from 3.7 percent, but that was also a good sign, resulting from an expanding workforce that increased the labor force participation rate to 63.1 percent. 

“The jump in payrolls in December would seem to make a mockery of market fears of an impending recession,” Paul Ashworth, chief economist at Capital Economics in Toronto, told Reuters. “This employment report suggests the U.S. economy still has considerable forward momentum,” he added.

What Next for the Fed?

Some analysts think the better – much better – than expected labor report will solidify the Federal Reserve’s plan to continue raising interest rates this year, which had seemed to be wobbling in the face of a gyrating stock market, political turbulence in the U.S. and growing concerns that the global economy may be slowing. 

Downplaying those concerns at its December meeting and ignoring angry tweets from the White House, the Federal Open Market Committee (FOMC), the Fed’s rate-setting arm, raised the benchmark interest rate for the fourth time in 2018. 

“Information received since the Federal Open Market Committee (FOMC) met in November indicates that the labor market has continued to strengthen and that economic activity has been rising at a strong rate,” the committee said in a statement after its December meeting. “Job gains have been strong, on average, in recent months,” the statement added, “and the unemployment rate has remained low.”

Fed Chairman Jerome Powell echoed those sentiments in his post-meeting press conference, signaling confidence in the economy’s underlying strength and a commitment to remain on the rate-tightening course the Fed has been following for the past year.

Rejecting suggestions that political and economic unease required at least a pause in the rate increases, Powell  said,“ We think this move was appropriate for what is a very healthy economy.”  The Fed Chairman also emphasized that President Trump’s criticism of the rate hikes “played no role” in the FOMC’s decision. “Nothing will deter us from doing exactly what we think is the right thing to do,” he stated. 

Economic Unease

There are some indications that the Fed’s assessment of the “right thing to do” may be moderating somewhat. Several Fed officials suggested in recent speeches that they are anticipating only two rate increases this year rather than the three the Fed has been signaling.  Those comments came before the strong December jobs report, but they also came before an impasse over funding for a wall on the Mexican border produced what is already the longest federal government shut-down in history. 

Fed Chairman Jerome Powell has made it clear that policy makers will base their assessments on the economy’s underlying strength, and some key indicators have begun to point downward. in the two weeks since the Fed’s December meeting, Wall Street Journal columnist Nick Timiraas noted in a recent article, “the economic outlook has turned gloomier. Market volatility has increased, stocks have tumbled, oil prices have plunged and yields on government debt have dropped sharply amid worries over a global growth slowdown. Yields on some longer-dated bonds have dropped below yields on short-term debt in recent days, an inversion that can sometimes precede a recession by one or two years.”

Economists polled by Reuters before the shutdown began put the odds of a recession developing in the next two years at 40 percent; New York Times columnist Paul Krugman, a Nobel prize-winning economist, asserted in a recent twitter post that “the Trump boom, such as it was, is over.” His crunching of current economic reports suggests that “a significant slowdown is currently underway—not a recession,” he emphasized, “but growth probably under 2 percent.”

Housing Market Concerns

The weakening housing market is generating some of the concern about the economic outlook. Although existing home sales managed anemic month-over month increases in October and November, sales for both months lagged significantly behind the year-ago pace.   The annual gap was 7 percent in November and 5.1 percent in October.  The November dip was the largest annual decline in seven years, according to the National Association of Realtors (NAR). 

Inventory levels improved in November, BUT most of the improvement was at the upper end of the market.  “There is still a housing shortage for affordable homes that many moderate to middle-income families will be looking for,” Lawrence Yun, the NAR’s chief economists, told the Wall Street Journal.

Pending home sales, measured by a National Association of Realtors (NAR) index fell again in November, registering the 11th consecutive month year-over-year decline.

Single-family home construction, which has been limping all year, declined for the third consecutive month, the Commerce Department reported, falling nearly 13 percent below the year-ago pace. Builder sentiment, measured by a National Association of Home Builders (NAHB) index, fell to its lowest level since May of 2015.

Choke or Hiccough?

Rising mortgage rates and higher home prices continue to batter the housing market, widening the affordability gap that is keeping many prospective homebuyers on the sidelines and leading some analysts to view the negative housing reports as closer to a choke than a hiccough. 

"I definitely think we're in a correction," said John Burns, CEO of John Burns Real Estate Consulting, told CNBC.   "Sales, according to our survey last month, were down 19 percent year over year. ... I would call that a correction.”

An unexpected dip in mortgage rates at year-end and a slowing in the rate at which home prices are rising may ease the affordability squeeze, analysts say - -but not much. Mortgage rates are still well above their year-ago rate, and home prices are still rising faster than incomes.  Instead of helping to power the economy, as it has in the past, housing may become a drag on growth, some analysts fear. 

“The best-case scenario” for housing is “a soft landing,” Ralph McLaughlin, deputy chief economist at CoreLogic Inc. suggests in a recent client note.  The worst-case scenario is considerably worse than that.

“The housing sector is stuck in neutral,” an analysis in CBS MarketWatch concludes. “The question now is whether it can regain some momentum in the new year.”