A Path to a Soft Landing
Even with the most aggressive pace of rate hikes in over a generation, recent data suggests that there’s still a path to a “soft landing” for the Federal Reserve. The U.S. economy posted the kind of mild slowdown in the last quarter of 2022 that the Fed wants to see as it attempts to tame inflation without choking off growth. Gross domestic product beat expectations to rise at a 2.9% annualized pace, down from 3.2% in the third quarter and a long way from a recession.
The PCE price index, the Fed’s preferred measure of inflation, rose 3.2% compared to 4.8% in the prior quarter. A separate report on labor markets published yesterday (weekly jobless claims unexpectedly fell) also points to a resilient economy, rather than one on the verge of a slump. However, the downside of a tight labor market is that it will keep the Fed concerned about wage pressures remaining persistently high. And the Fed already has in the back of its mind that it needs to avoid the same mistakes seen in the 1970s when rates were constantly cut at the first sign of disinflation only to see inflation shoot higher again.
A Game of Chicken
The fed funds futures are a lock for a 25 BPS rate hike next week, which would put the target rate at 4.5% to 4.75%. Now that the pace of rate hikes have slowed, yield curve dynamics are becoming more important. Bets still favor a rate cut by November or December of this year even though the Fed hasn’t flinched on its anti-inflation rhetoric. There are many people out there that believe the bond markets have gotten ahead of the Fed’s messaging when it comes to the time value of money, and it’s turning into a game of “chicken” with the Fed.
A soft landing refers to an economic scenario where tighter monetary policy cools spending and lowers inflation while avoiding a recession.
Rising costs across the economy have been discouraging potential home buyers. That home sales are likely to slow this year is apparent due to high mortgage rates (the 30-year lending rate is at roughly 6.15%) and a median new home sale price at a near-record $471,200. Fortunately, most potential buyers are adjusting their plans accordingly by increasing their savings and either spending more than they had hoped or delaying purchases. The 3% mortgage rates of the pandemic are probably not coming back, at least in the near term.
Housing Supply and Demand
New home sales rose 2.3% month-over-month to a seasonally-adjusted annual pace of 616,000 in December, the highest pace since August. This is down 26.6% on a year-over-year basis, showing that higher prices have a built-in governor: prices will increase until they decrease demand, eventually falling back to a new equilibrium. As home price appreciation stagnates, that will help to ease inflation.
An estimated 644,000 homes were sold in 2022, which was a 16.4% decline from 2021. For all the talk of “supply destruction” in the housing market due to people not wanting to give up their low rates, the drop in sales has helped send the monthly supply of new homes available for sale (461,000 at the end of December) to nearly nine months, well above the six-month average seen since February 2020. Six months of supply is considered a balanced market, which should help alleviate the problem of affordability as it will help pressure prices lower. Additionally, the pullback in mortgage rates has spurred some renewed demand among home buyers.