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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Economic mood swings of late have followed the trajectory of a rubber ball bouncing on an uneven surface – up a little, down a lot, skittering to one side then another, forward and then back, the direction altered (and sometimes skewed) both by economic turbulence and gale force political winds.

Mirroring that bouncing ball effect, the stock market:

  • Plummeted as political gridlock pushed the debt ceiling debate beyond the eleventh hour, bringing the country to the brink of default;
  • Recovered, as the debt ceiling issue was resolved (at least temporarily), then
  • Swooned once more as Standard & Poor’s lowered the nation’s credit rating for the first time in its history;
  • Rebounded strongly on Federal Reserve Chairman Ben Bernanke’s pledge to keep interest rates low for the next two years and on economic reports that proved either more positive than expected or less negative than feared, but
  • Sank again as July’s dismal employment report reflected zero job growth for the month, underscoring the fears of analysts who have been warning that the risks of another recession are mounting.

Recalculating Recession Odds

The July employment report obscured a flurry of more or less positive economic indicators that had led some previously pessimistic analysts to conclude that the recession risks may have been overstated. Retail sales increased in July (even though consumer confidence tanked), consumer income grew and consumers demonstrated an increased willingness to borrow money, pushing credit card balances up and savings rates down.

Factory orders increased in July on the strength of auto sales, which analysts found particularly encouraging. The Index of Leading Economic Indicators also rose in July – not by much (0.5 percent), but the direction was positive and followed another small (0.3 percent) increase in June.

The Federal Reserve reported that factory output increased in June at the strongest rate this year and lenders relaxed their credit standards on most types of loans – more encouraging signs for those looking for reasons to argue that a double-dip recession was not inevitable.

“You look at what companies are saying in their earnings calls and there is no indication that companies are cutting back abruptly in their hiring or spending,” Neil Dutta, an economist at Bank of America Merrill Lynch, told Bloomberg News. “While recession risks are on the rise, a recession is not baked in the cake and the data bear that out,” he added.

Dutta’s comments, and, indeed, most of the positive economic reports, came before the deficit debate brinksmanship roiled markets and jangled the already raw nerves of consumers and investors, and before the July employment report “pounded another nail in the recovery coffin,” as one analyst put it, further eroding consumer confidence levels that had already fallen to the lowest point since the depths of the recession, in April of 2009.

On the Wrong Track

Fannie Mae’s most recent National Housing Survey found that the percentage of consumers who think the economy is on the wrong track increased from 57 percent in January to 70 percent in July. And nervous consumers don’t buy homes, Doug Duncan, Fannie’s chief economist, observed.

“Macroeconomic factors are clearly driving the mindset of consumers, and housing is being impacted by this,” Duncan said in a press statement. But concern about the economy has replaced uncertainty about the housing market as the primary obstacle keeping prospective homebuyers on the sidelines, he noted. “[D]espite historically low interest rates, consumers are still saying they don’t see this as a good time to go out and borrow money to buy a house,” Duncan said.

Mortgage interest rates at their lowest level since 1971 have not been enough to overcome those concerns; mortgage origination activity has shrunk to the lowest point in 14 years, the Mortgage Bankers Association (MBA) reported, with most of the current loan volume attributable to the refinancing of existing loans.

New home sales declined in July for the third consecutive month, with home starts and (not surprisingly) builder confidence moving in the same direction. “Sales of new homes are going nowhere fast,” Celia Chen, senior director at Moody’s Analytics, told Housing Wire.

The same could be said of existing home sales, which fell by 3.5 percent in July, reaching their lowest level in the past eight months. The National Association of Realtors (NAR) blamed overly conservative appraisals and tight lending standards for depressing demand, but some analysts pointed to other factors.

“The real problem is simply weak demand,” Patrick Newport, U.S. economist at HIS Global Insight, wrote in a memo analyzing the housing statistics. "Buyers are worried about falling house prices, the job outlook, the stock market, and gridlock in Washington, D.C.” Tight credit “is playing a role, of course,” he agreed. “But one reason credit is tight is that demand is weak."

Chicken or Egg

In the complex interplay of economic forces in the housing market, it is difficult to distinguish between cause and effect — whether falling home prices are discouraging demand, or whether the lack of demand is responsible for the overhang of unsold properties that is depressing prices. But identifying the chicken and egg in this equation probably doesn’t matter – the result either way is a self-perpetuating cycle that is pushing prices down, keeping buyers out of the market and trapping the housing market in a choke-hold.

Prospects for near-term relief seem dim, but analysts have spotted a few glimmers of hope, among them:

  • The cost of renting a home now exceeds the cost of buying one in nearly three-quarters of the country’s 50 largest cities, according to a report by Trulia, a real estate Web site, suggesting, Trulia says, that the market is close to a “tipping point” that will spur homebuying activity.
  • The “shadow inventory” created by foreclosed homes and homes in the foreclosure process has been shrinking. A Standard & Poor’s analysis estimates that it will take about 47 months to clear the distressed properties that are clogging for-sale listings and pressuring home prices, five months less than the first quarter estimate and the largest quarter-to-quarter decline in nearly three years.
  • The foreclosure crisis has peaked. That’s according to RealtyTrac, which has decided that the continuing decline in foreclosure filings reflects real progress and is no longer a product of the processing delays created by the robo-signing mess. Foreclosure filings declined another 4 percent in July compared with June, the 10th consecutive drop in that statistic, and a 35 percent improvement over the year-ago total.
  • “The downward trend in foreclosure activity has now taken on a life of its own," RealtyTrac CEO James Saccacio said in a press statement. "It appears that the foreclosure processing delays, combined with the smorgasbord of national and state-level foreclosure prevention efforts … may be allowing more distressed homeowners to stave off foreclosure."
  • The number of homes listed for sale also declined in July, falling 1.2 percent from the June total and by 18 percent compared with the same month last year. Some analysts viewed this as a positive trend in line with the drop in foreclosure filings; others saw evidence that foreclosure delays continue to plague the housing market. Another possibility: Would-be sellers are keeping their homes off the market because negative equity prevents them from selling or because they assume they won’t be able to find interested buyers both willing to purchase their homes and able to obtain the financing they need to do so.
  • The rate at which home prices are declining slowed in June – another statistic that some analysts find more significant and more encouraging than others. The closely watched S&P/Case-Shiller 20-city index of property values fell by only 0.1 percent in June compared with May, matching the small April-to-May decline and suggesting to some that home values may finally be stabilizing. An NAR index also registered its smallest quarter-to-quarter decline in more than four years in the second quarter (0.4 percent); a separate analysis by Zillow found that prices actually increased in some markets and the number of owners with negative equity declined.

A Bumpy Road

The improvement is “very encouraging,” Stan Humphries, Zillow’s chief economist, said in a press statement. “But we have to remember that this is coming on the heels of one of the worst quarters since the housing recession began. There will be many ups and downs in home values before this is over,” he added. “We expect a bumpy road ahead.”

Paul Dales, senior U.S. economist at Capital Economics Ltd. in Toronto, agrees that the recovery road will be both bumpy and long. “Prices aren’t going to rebound back rapidly,” he told Bloomberg News. “Most people think that when the downturn ends the recovery will be pretty good, but that’s not going to be the case at all.”

Some analysts fear the economy and the housing market have become entangled in a Gordian knot, with the weak economy depressing the housing market and the depressed housing market impeding the economic recovery. Best case forecasts see the recovery gaining traction sometime next year. But there is growing concern that both the economy and the housing market are mired in ditches from which neither has sufficient strength to emerge without help that the other can’t provide.