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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We’ll talk about the employment report a little later (it was better than pessimistic analysts expected) but just for fun, let’s start with the housing data, only because it continues to bewitch, bother and bewilder analysts trying to interpret it. The March reports were no exception.

Existing home sales surged for the month, increasing by more than 6 percent over February to reach their highest level in more than two years – and providing some reassurance to analysts rattled by the unexpected 5 percent sales dip in January that had called into question upbeat forecasts for the year.

New home sales – 11 percent below February’s unexpectedly strong pace — were certainly less reassuring. But what was most interesting was the way – or ways – in which the data were reported in various news media. Reflecting classic “half empty or half full” disparities, some headlines emphasized the steep month-to-month decline, while others focused on the 20 percent year-over-year increase, the latter indicating to Bloomberg News that “progress in the industry will be healthy.”

Starts and permits suggested otherwise. Housing starts for March were essentially flat compared with a February figure that was the weakest in more than a year, while permits (an indicator of future volume) were 5.7 percent lower in March than in February. But there were glimmers of good news here, most important among them: New single-family construction increased by 4.4 percent, compared with a 7 percent multi-family decline. Single-family permits also increased a little, while multi-family permits plunged by nearly 16 percent.

Given that the miserable winter weather lingered in most areas well into March, “it may have been premature to expect a meaningful rebound before April,” Michelle Girard, an economist at RBS, told MarketWatch.

No Quick Comeback

“Housing isn’t going to come back immediately,” Lewis Alexander, chief economist at Nomura Securities International, agreed. “But that doesn’t mean it’s not going to come back,” he told the Wall Street Journal.

Builders seem to share that optimistic view, notwithstanding the March decline in sales and starts. The National Association of Home Builders’ confidence index reached a three-month high in April, with builders reporting improvements in both current prospective buyer traffic and future sales prospects.

The NAHB’s chief economist, David Crowe, has high hopes for this year and “we expect 2016 to be even better,” he said in a recent report, with momentum combine “a significant amount of pent-up demand,” supported by an economy “that will be entering a period of reasonable strength and consistency.”

“We’re reconnecting with fundamentals,” Robert Denk, an NAHB senior economist, added. “No matter what bucket you look at, the numbers are getting better. We really have turned the corner. We’re seeing a broader recovery all around.”

NAHB economists aren’t the only ones seeing the housing glass as half-full. Freddie Mac economists, similarly encouraged by low rates, strengthening employment, and pent-up demand, are predicting that the housing market this year could be the best since 2007.

“Even Better News”

Pending sales, tracked in a National Association of Realtors (NAR) Index, seem to be moving in the right direction. The index jumped 3.1 percent in March, reporting the third consecutive month-over-month increase and the seventh consecutive year-over year gain. “Even better news,” Lawrence Yun the NA’s chief economist said, is evidence that the buyer pool is dominated now by owner-occupants, with long-term mortgages and long-term mind-sets, rather than by investors buying with cash and near-term profits on their minds.

But Yun also cautioned that scant inventories are creating problems in some markets, pushing prices “to unhealthy levels,” beyond reach for many would-be buyers. “Simply put, housing inventory for new and existing homes needs to improve measurably to improve affordability,” he said.

Although appreciation rates have moderated over the past year, prices are still rising. The S&P Case-Shiller 10-city index increased by 4.8 percent in February (vs.4.3 percent in January) and the 20-city index was up by 5 percent, compared with a 4.5 percent annual increase the previous month. Although the national index (up 4.2 percent year-over year in January) has increased for 34 consecutive month, prices remain about 10 percent below their pre-collapse peak in July of 2006.

“If a complete recovery means new highs all around, we’re not there yet,” David Blitzer, managing director and chairman of S&P’s Index Committee, told Housing Wire.

A Double-edged Sword

Rising prices are something of a double-edged sword for housing, encouraging owners to put their homes on the market, but creating affordability pressures that deter some buyers. Slowing appreciation rates also cut two ways – easing affordability pressures on buyers, but impeding the recovery of underwater homeowners whose outstanding mortgages exceed the value of their homes. Zillow estimates that 17 percent of homeowners with mortgages were in that position last year.

“Negative equity is likely to remain a persistent feature of the housing market for years,” Stan Humphries, Zillow’s chief economist predicts, and the effects will be felt most strongly at the lower end of the market, reducing the supply of homes affordable for first-time buyers. “As we enter this new normal,” Humphries predicts, “negative equity may return as a heated topic of concern to policy makers, given its stubborn refusal to go gently into that good night.”

Analysts seeking other causes for concern find them in still lackluster wage gains that aren’t keeping pace with rising home prices, and in the failure of millenials to create the first-time buyer surge a sustained housing market recovery requires. Household formation rates jumped in the first quarter, but homeownership rates sank to a 25-year low, as most of the new households are moving into rentals rather than buying homes of their own.

Rising rents (up 3.6 percent since 2014 and up 11 percent over the last 3 years) and shrinking rental inventories may provide the spark that will persuade more renters to become homeowners.

"With credit conditions now loosening and employment set to continue growing strongly, we suspect this long downward trend [in homeownership rates] may not last for much longer," Ed Stansfield, chief property economist at Capital Economics, told Reuters.

Focusing on Employment – and the Fed

The housing market outlook will depend largely, if not entirely, on employment growth and interest rate trends. Which brings us to the April employment report: Employers added 223,000 positions, for the month, falling a little short of the consensus forecast but handily beating the most pessimistic projections. The March report, on the other hand, was revised downward from extremely disappointing (126,000) to dismal (85,000). The stock market, struggling most of the week, rebounded on the news, less because the job picture seemed to improve than because it did not improve enough (in the opinion of most analysts) to make a near-term interest rate hike likely.

The Fed Reserve has been inching closer to a decision to raise the Fed Funds rate, but isn’t there yet and may have backtracked a little, in the wake of slower than expected first quarter growth and that disappointing March employment report.

Meeting before the April report, the Federal Open Market Committee, the Fed’s policy-making arm, said the said the Fed will make a rate move “when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.”

Analysts, who had been predicting a rate increase as early as June, are now saying it’s not likely before September at the earliest, and may not come until next year.

The closely watched and much-parsed FOMC statement did not specify a timeframe, but seemed to suggest that Fed policy makers are inclined to move more slowly than inflation hawks would like, to avoid a premature rate hike that could derail the economic recovery.

“The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels,” the statement said, “economic conditions may, for some time, warrant keeping the target federal funds rate below levels the committee views as normal in the longer run.”

The March employment gains probably did not alter that position.