Federal Reserve Continues to Push Against Inflation but the Labor Market Is Pushing Back

Two months into the new year, consumers are spending less, economic growth has slowed, the inflation rate has declined (although arguably not as much as the Fed would like), and the over-heated housing market has cooled.

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Critics have sometimes complained that the Federal Reserve’s policy announcement are difficult to fathom. But there was nothing opaque about  the message Fed Chair Jerome Powell delivered following the January Federal Open Market Committee (FOMC) meeting: The Fed is going to begin raising interest rates in multiple steps beginning in mid-March.

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The unemployment rate is falling, job openings abound, wages are rising, the housing market is booming – and consumers feel miserable.  That’s the takeaway from October data reflecting a sharp dichotomy between how the economy is doing (reasonably well)) and how consumers are feeling about it – not well at all.

More than 70 percent of the consumers responding to Fannie Mae’s November National Housing Survey said the economy is on the “wrong track,” a 5 point month-over month increase and the most negative view this survey has found in the past decade.

The University of Michigan’s consumer sentiment survey, similarly, plummeted in November to depths last seen when the economy was struggling to emerge from the ‘Great Recession’ of 2007-2009.

For increasingly gloomy consumers, inflation is the major source of discontent.  The survey noted “the growing belief among consumers that no effective policies have yet been developed to reduce the damage from surging inflation.” Consumer prices increased 6.2 percent year over year in October, the steepest jump in more than 30 years. 

Some analysts contend that excessive stimulus – pandemic assistance payments from the government and Fed policies that have kept interest rates low – are to blame.  Others argue that the pandemic has triggered temporary problems – outsized demand, delivery bottlenecks, and supply shortages – that will self-correct as the pandemic wanes.   

Fed’s Dilemma

This creates a dilemma for the fed – which has to walk a fine line between keeping inflationary forces from getting out of hand and avoiding moves (raising interest rates) that would short-circuit a still strong recovery and might tip the economy into a recession.

After holding firmly to the belief that inflationary pressures would prove transitory, Federal Reserve Chairman Jerome Powell acknowledged that the pressures were proving less transitory than Fed analysts had expected. In recent Congressional testimony, he explained: :  “What’s happened—and we’re very, very straightforward about it—is that inflation has come in higher than expected, and bottlenecks have been more persistent and more prevalent….We see that just like everybody else does, and we see that they’re now on track to persist well into next year.”

As a result, the Fed may accelerate its schedule for “tapering” purchases of Treasuries and mortgage-backed securities, ending that process by March instead of closer to the end of next year as policy-makers had planned.  Faster tapering would create the option of boosting interest rates sooner if they decide tightening is needed to combat inflation. 

Among the variables the Fed will consider is the evolution of Omnicron – the newest and now rapidly-spreading COVID variant.  The preliminary consensus appears to be that the impact will be less severe than the initial pandemic wave, and so unlikely to alter the Fed’s current policy plans. But analysts acknowledge the consensus is based on what is still an uncertain outlook.

Where does that leave us now, heading into the holidays?  Here’s a brief summary.

 Employment: Signs of Weakness

The economy gained a paltry 210,000 jobs in November – less than half the total analysts were predicting.  The unemployment rate fell to 4.2 percent from 4.6 percent, but the sagging labor force participation rate continued to sag, as unemployed workers  remained far less enthusiastic about  accepting open positions than desperate employers are to fill them.  The job-search site Zip-Recruiter estimates that there are currently 11 million job openings compared with about 7  million unemployed workers who say they are looking for jobs.

“That’s the lowest ratio of unemployed people to job openings we’ve ever seen and that is contributing to unprecedented tightness in the labor market,” Julia Pollak, chief economist for the company, told the Wall Street Journal.

People who have jobs are also leaving them in record numbers. More than 4.4 million workers quit in September, the Labor Department reported.  The quit rate declined slightly in October, but remained in record territory.

“The real problem is… can we get the labor force participation rate to change meaningfully?” Ron Hetrick, a senior labor economist at Emsi Burning Glass, told NBC News.com.  “That is the primary thing holding us back.”

Omnicron remains a key variable in both the employment and the inflation forecasts.  If public health conditions worsen, and or if fear of the virus keeps workers out of the labor market, labor shortages will put upward pressure on wages, possibly triggering the traditional wage-price inflation spiral that we haven’t seen yet but that many analysts fear.   

Housing: More of the Same

The housing market continues to do what it’s been doing all year - -defy predictions that it is going to stumble. Existing homes sold at a seasonally adjusted annual rate of 6.34 million units in September, almost 6 percent below the year-ago pace but well above a consensus forecast anticipating a seasonal slowdown that hasn’t occurred.

Redfin’s Homebuyer Demand Index posted its highest reading in the past four years in November as buyer demand for homes continues to outstrip the supply.

New home sales also beat predictions, managing a 0.4 percent increase over September’s 742,000 rate – revised downward from the initially reported 800,000 units. 

Home starts and permits have increased a little, but inventory levels remain depressed.  The National Association of Realtors (NAR) reported 1.25 million homes available for sale in October, 12 percent fewer than in the same month a year ago.

Home prices, which have been rising steadily, are still increasing, albeit more slowly, but you have to look closely to notice the difference.  The Case-Shiller National Home Index  recorded an annual increase of 19.5 percent in September compared with a 19.8 percent gain in August.  CoreLogic’s Home Price Index jumped by 18 percent year-over-year in October, the largest year-over-year gain since the index was created 45 years ago.

Rising prices, inventory shortages and inflation fears have dampened consumers’ spirits, but, apparently, not their determination to buy homes.  Pending home sales – an indicator of future transactions – increased by 7.5 percent in October, recovering from a 2.3 percent dip in September.  Analysts had expected a recovery, but a smaller one. Lawrence Yun, the NAR’s chief economist says rising rents and fears that mortgage rates will rise, and consumers’ ‘sound financial footing’ are fueling demand. 

"Home sales remain resilient, despite low inventory and increasing affordability challenges," he noted, while "inflationary pressures may have some prospective buyers seeking the protection of a fixed, consistent mortgage payment."  Despite the challenges the pandemic, inflation fears, rising home prices and anemic inventories have created this year, Yun predicts that sales will exceed 6 million, “which will shape up to be the best performance in 15 years.”

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