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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Predictions that the Fed would increase interest rates at its June meeting were virtually unanimous, and the Federal Open Market Committee, the Fed’s policy-making arm, didn’t surprise or disappoint. 

The 25 basis point increase the committee announced, its third consecutive adjustment, pushed the target range for the Fed Funds rate to between 1 and 1.25 percent.  The increase “reflects the progress the economy has made,” Fed Chair Janet Yellen said in a press conference following the FOMC meeting.

But the Fed action also ignored the persistent lag in the inflation rate, which continues to fall short of the Fed’s 2 percent target.  Fed officials have maintained that a strengthening labor market will produce salary hikes and a higher inflation rate, reflecting economic strength.

Although that ‘virtuous cycle’ hasn’t materialized yet, the June employment report provided a strong dose of good news in other areas.  Employers added 220,000 jobs for the month, erasing a weaker-than-expected May report. Revisions added nearly 50,000 jobs to the relatively weak April and May reports.  The unemployment rate inched up slightly, as nearly 5 million discouraged workers, who had given up on finding jobs, re-entered the market.

Wage gains remained smaller than economists would like to see, but apparently large enough to make consumers feel better about their finances.  More than one-third of the  adults responding to a New York Federal Reserve survey said they are better off economically today than they were a year ago (a high point for this survey sine it was introduced four years ago) and more than half said they expect to spend more this year than they did last year.

Somewhat less encouraging for the Fed, which is basing its rate-hike plans on the expectation that inflation will increase,  consumers’ inflation expectations, reflected in the New York Fed survey, have declined to a four-year low.  But longer-term inflation expectations ― over the next three years — have jumped, lending some support for the Fed’s assumption that the current inflation lag won’t last much longer. 

Thinking vs. Doing

Consumers may be planning to spend more, but they haven’t begun taking money out of their wallets yet.  The Commerce Department reported that purchases increased by a negligible 0.1 percent in June, while the savings rate increased to 5.5 percent – its highest level in nearly a year. 

Housing reports reflect a similar disconnect between what consumers say and what they are doing.  Although more than 70 percent of the homeowners responding to the National Association of Realtors’ (NAR’s) quarterly HOME survey said they think this is a good time to sell, those positive thoughts haven’t produced an increase in listings, which remain sparse.

“There are just not enough homeowners deciding to sell because they're either content where they are, holding off until they build more equity, or hesitant [because they see] it will be difficult to find an affordable home to buy," Lawrence Yun, the NAR’s chief economist, suggested.   Whatever the reasons, the reluctance of existing owners to sell their homes is starving the market of the inventory it needs to keep pace with buyer demand.

Drawn in part by the prospect that mortgage rates will be increasing, more buyers are entering the market, but the lack of inventory is leaving many frustrated.  Those frustrations are reflected in the widening confidence gap between potential sellers and potential buyers.  The percentage of homeowners who think this is a good time to sell jumped by 7 points in Fannie Mae’s Home Purchase Index for the second quarter, while the share of renters who think this is a good time to buy rose by only 3 points. 

Darker Numbers

The Fannie Mae survey also found consumers to be considerably less upbeat than the New York Fed survey noted earlier.  After reaching a HOME survey high of 62 percent in the first quarter of this year, the percentage of respondents who think the economy is improving dropped to 54 percent in the second quarter; the “personal financial outlook index” also dipped, as fewer homeowners said they expect their finances to improve in the next six months. 

Renters are feeling particularly glum, and that’s not surprising, the NAR’s Yun noted.  “Paying more in rent each year and seeing home prices outpace their incomes is discouraging, and it is unfortunately pushing home ownership further away, especially for those living in expensive metro areas on the East and West Coast.”

Despite the drag created by the shortage of listings and the affordability pressure created by still rising prices, existing home sales increased by a little more than 1 percent in May compared to the previous month, totals for which were revised lower.  

“The fact that sales of existing homes rose in May, despite incredibly limited selection, shrinking times on market and rapidly rising prices, is a testament to just how strong the draw to homeownership is right now for millions of Americans,” Svenja Gudell, chief economist for Zillow, told Housing Wire “It's no exaggeration to say that current buying conditions in many markets are terrible, with sellers in complete control and buyers forced to contend with cutthroat competition and intense pressure to make a deal,” she added. 

“Lopsided” Conditions

 “Current demand levels indicate sales should be stronger,” the NAR’s Yun added, “but it’s clear some would-be buyers are having to delay or postpone their home search because low supply is leading to worsening affordability conditions.”

Listing constraints appear to have cut sharply into pending sales, which declined in May for the third consecutive month.  The problems are most apparent at the lower end of the price range: Compared with last year, pending sales declined by more than 7 percent for homes priced below $100,000, and increased by only 2 percent for homes priced between $100,000 and $200,000. By stark contrast, pending sales for homes priced between $750,000 and $1 million jumped by 26 percent.   

Those disparities are creating “lopsided” conditions, Yun said, with investors and repeat buyers with large down payments accounting for the bulk of activity in many markets.

Although new home sales increased in May (reversing a steep May decline), housing starts and permits for new construction both declined, deepening the concern of housing analysts who fear  that today’s housing shortage could turn into a full-fledged housing emergency.

The listing shortage is already “freaking us out,” Glen Kelman, CEO of Redfin, told CNBC. “I think the overall industry for the first time is seeing sales volume really limited by the inventory crunch."