The New Year is beginning where the old one ended -- with uncertainty about when – or whether – the Federal Reserve will begin cutting interest rates. Increasing evidence that inflation is easing has fueled speculation that the Fed would begin cutting interest rates this year. Indeed, the minutes from the December meeting of the rate-setting Federal Open Market Committee (FOMC) indicated that policy makers had “penciled in” three quarter-percentage point cuts over the next 12 months.
Key economic reports have indicated that the Fed is winning its battle against inflation, or at least making notable progress toward that goal. Although the annual inflation rate increased more in December than in January (3.4 percent vs. 3.1 percent), the Fed’s preferred index of “core prices” declined from 4 percent to 3.9 percent – the first time this gauge has fallen below 4 percent since 2021.
“The progress on inflation since June 2022 has been remarkable,” David Kelly, chief global strategist at J.P. Morgan Asset Management, told the Wall Street Journal. “The bottom line is that the most likely path for inflation from here is not upwards or sideways but rather down.”
Fed Chair Jerome Powell set an optimistic tone in his comments following the December FOMC meeting. “Inflation keeps coming down,” he told reporters, and “the labor market keeps getting back into balance; it’s so far so good. We kind of assume it will get harder from here,” he added, “but so far it hasn’t.”
Policy Question Marks
Although Powell’s comments and the minutes of the FOMC meeting reflect growing confidence that the Fed will achieve the “soft landing” it has been trying to engineer – taming inflation without boosting unemployment and triggering a steep economic downturn. But the minutes also note “an unusually elevated degree of uncertainty” about future policy decisions., acknowledging that despite current favorable trends, economic conditions may not warrant the multiple rate cuts Fed officials and the financial markets are anticipating.
The stronger than anticipated December employment report underscored that point. Employers added 216,000 jobs for the month, reflecting the continued resilience that has helped avoid the recession many feared, but that may also prevent the Fed from cutting rates as much or as quickly as they might like.
Uncertainty about the timing and size of rate cuts doesn’t diminish the tangible inflation progress, however, progress that consumers are slowly recognizing. Consumer confidence, measured by two monthly surveys, rebounded in January while recession fears declined. Although survey respondents say they are still concerned about inflation, they are also reporting plans to purchase big-ticket items, including homes. The percentage of respondents planning to buy a home in the next six months increased to nearly 6 percent in the November Conference Board survey.
That confidence isn’t reflected yet in home sales, however, as prices and interest rates have eroded affordability, while depleted inventories have limited choices for buyers who are trying to navigate the challenging market. A National Association of Realtors (NAR) affordability index fell in November to its lowest level in more than four decades.
Homeowners “Hording”
There have been a few positive housing market indicators. Existing home sales increased slightly in November after five consecutive monthly declines that had pushed annual sales to a 13-year low; the inventory of existing homes also rose slightly (very slightly) year-over-year. Mortgage rates, which peaked near 8 percent in October, have been declining steadily since then, closing the affordability gap and encouraging at least some buyers to explore available listings. But lower rates haven’t fallen enough to persuade existing homeowners to relinquish their existing very low-rate mortgages, leading them, in the words of one analyst, to “horde” their homes rather than sell them, depriving the market of the listings it needs and keeping prices high.
The S&P CoreLogic Case-Shiller Home Price Index increased by nearly 5 percent year-over-year in October, after posting a 4 percent annual gain the previous month. An increase in new home construction is providing some inventory relief (permits and housing starts both increased year-over-year in November), but not enough to compensate for the dearth of existing homes for sale. Inventory levels are still almost 40 percent below the pre-pandemic norm.
The Wall Street Journal recently noted this persistent problem: “The current dichotomy between more buyers who see mortgage rates as attractive enough to transact and homeowners who still consider them too steep to sell is likely to keep the housing market from really taking off.”