Employment Cooling, Housing Slipping as Fed Continues to Combat Inflation

The nation’s red hot labor market cooled a bit in August, indicating that the Federal Reserve’s inflation-fighting efforts may be having the desired effect. But Fed officials aren’t declaring victory yet. Far from it.

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With the too-close-to-call election still a few days away as this update was being written, and the East Coast struggling to recover from Hurricane Sandy, interest in the current batch of economic reports had dimmed considerably. But the focus on one issue ─ the “fiscal cliff” — has remained laser sharp, and the concern about it is widespread.

Most analysts agree that the cliff (shorthand for a package of tax hikes and spending reductions that will be triggered automatically in January if Congress fails to reach a bipartisan compromise on a plan for addressing the deficit), has become a significant drag on the economy and poses the biggest risk to growth going forward, regardless of who wins the Presidential race and notwithstanding how long it takes to restore power to storm-battered communities.

A measure of just how large that figurative cliff looms for business leaders was a letter signed by the chief executives officers of 80 major U.S. corporations, saying they would accept higher taxes “accompanied by significant spending restraint,” as part of a plan for reducing the deficit. The letter describes the blueprint proposed by the Bowles-Simpson deficit reduction commission — $3 in spending cuts for every $1 of tax increases — as an "effective framework" for addressing "a serious threat to the economic well-being and security of the U.S."

A report released last week by the National Association of Manufacturers (NAM)echoed that concern, warning that failure to avoid the cliff would slash more than 6 million jobs over the next two years and send the economy tumbling back into another recession.

The NAM report estimates that concern about the fiscal cliff has already slashed GDP growth by about half of one percent, as business executives prepare for their worst case projections.

Precautionary Measures

“People are taking precautionary measures,” Jeff Werling, executive director of the University of Maryland’s Interindustry Forecasting Project, which prepared the report, told the Washington Post. “Even if you think there’s not much of a chance of this happening,” he added, “businesses and consumers are still worried.” And those concerns are reflected in declining manufacturing activity and still sluggish employment growth – a major factor behind the Federal Reserve’s decision to keep interest rates down and continue its efforts to boost the job market.

“The committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions," Fed officials said following the most recent meeting of the Federal Open Market Committee. The Fed’s policy-making arm decided to continue purchasing mortgage-related and government debt until there is clear evidence that hiring activity is accelerating.

The most recent labor market report, released last week, brought some encouraging news on that front. Employers added 171,000 workers to their payrolls – beating the most optimistic forecasts for job growth – and the totals for August and September were both revised upward by a combined total of almost 85,000. The unemployment rate ticked up a bit, from 7.8 percent to 7.9 percent, but that also qualified as good news, indicating that many previously discouraged workers have re-entered the job market.

Other reports have been mixed, providing evidence of strengthening in some sectors and signs of weakness in others. In the weakening camp:

  • Business investment stalled in September as corporate executives tabled plans to purchase new equipment. “Businesses are not prepared to commit to big-ticket investments,” said Nigel Gault, chief U.S. economist at IHS Global Insight, told Bloomberg News. “The uncertainty and global slowdown are clear negatives for capital spending. The third quarter was soft,” Gault noted, “and we can’t see the fourth quarter being much better.”
  • Manufacturing activity was a little less anemic in October than it had been in the previous three months, but this sector remained week. Markit’s Purchasing Managers Index inched up to 51.3 from 51.1 – just over the line that indicates expansion ─ but not by much.
  • Business confidence, as measured by the National Federation of Independent Business’s optimism index, also slipped for the fourth time in the past five months. The components reflecting hiring plans and investment purchase plans fell by six and three percentage points, respectively.

Many Positives

On the positive side of the ledger: The third quarter growth rate was much stronger (2 percent annualized) than expected, buoyed by unexpected strength in consumer spending; the Index of Leading Economic Indicators increased by 0.6 percent —the biggest jump in the past seven months; and consumer confidence indexes reached their highest levels in the past five years.

Enthusiasm over the consumer spending increase (0.8 percent in September) was offset somewhat by an accompanying decline in the savings rate (the lowest level since November of last year) and the flatness in disposable income, suggesting to Stephen Stanley, chief economist at Pierpont Securities, that the upward spending trend “is not fully sustainable. We’ll see whether the consumer can keep it up,” he told Bloomberg.

Other analysts have found the recent confidence readings more persuasive, noting in particular the solid increases in both current conditions (88.1 in October vs. 85.7 in September) and future expectations (82.6 vs. 78.5) components of the Thomson/Reuters University of Michigan survey.

Housing Confidence

Fannie Mae has also found increasing confidence in the housing market in with 37 percent of the respondents to the GSE’s September National Housing Survey predicting that home prices will increase over the next year – the highest level since Fannie began this survey two years ago. Nearly 20 percent said this is a good time to sell and more than 40 percent said they think the country is on the right economic track, compared with only 33 percent in August – both record highs for the report.

“Consumers are showing increasing faith in the nascent housing recovery,” Doug Duncan, Fannie’s chief economist said, and that confidence is reflected in the home sales statistics

Existing home sales declined slightly in September compared with August (4.75 million vs. 4.83 million annualized), but the decline was mainly “payback” for the significant gain in August, David Carrier, chief economist for NAFCU, said in a recent report. The National Association of Realtors (NAR) attributed the decline to an “acute lack of supply,” noting that inventory levels have fallen to a 5.9 month’s supply ─ the lowest level of available homes in September in nearly a decade.

Conspicuous by its evidence —and happily so ─ is any sign of the “shadow inventory” of distressed homes that analysts have warned could come crashing into the housing market and seriously disrupt the recovery parade. Gleb Nechayev, an economist with the real estate firm CBRE, credits investors, who have been sopping up foreclosed homes and converting them to rentals, with preventing that influx.

“We reckon that around 700,000 homes a year are being converted from owner to rental," he told Fortune. “That's preventing any buildup in the inventory of existing homes."

Upward Trajectory

Although pending home sales were flat in September compared with August, Lawrence Yun, the NAR’s chief economist, pointed out that the index was 10.7 percent higher than in September of 2011, suggesting that the overall trend remains positive. The trade group is predicting that existing home sales will increase by about 9 percent his year and by about the same amount in 2013.

New home sales have also been strong and growing stronger, hitting a two-year high in September, 27.1 percent higher than in the same month last year. Starts hit a two-year high (an annualized rate of 872,000 units) and permits, an indicator of future activity, were nearly 45 percent higher year-over year.

RealtyTrac dumped a little cold water on those positive reports, with a study of housing market conditions in 919 counties nationwide, finding that 65 percent of them are worse off now —based on home prices, inventories and unemployment — than they were in 2008.

But if you prefer to look at this glass as half full rather than half empty, the National Association of Home Builders/First American Title’s Improving Markets Index will help. It shows that 103 metropolitan areas made the ‘getting better’ list in October, up from 99 in September and the best reading recorded to date in this year-old report.

Kurt Pfotenhauer, vice chairman at First Americana, termed this “an important milestone on the road to recovery” in the housing market.

Home builders are clearly feeling better about their world. The NAHB/Wells Fargo builder sentiment index recorded its sixth consecutive increase in September, reaching its highest level since June of 2006. The current reading (41) is still below 50, however, meaning more builders remain negative than positive about the outlook, and the reason isn’t hard to understand, the NAHB’s chief economist, David Crowe, told reporters.

Although the housing market is recovering, the pace remains slow, Crowe explained. “Various constraints, such a tight credit, difficult appraisals and…the limited inventory of buildable lots in certain markets…are complicating factors that make it difficult for builder confidence to reach and surpass the 50-point mark.”

Still, shrunken inventory levels, record-low interest rates and slowly rising prices are strengthening demand for both new and existing homes. The S&P Case-Shiller index of property values recorded its largest year-over year gain (2 percent) in August following a 1.2 percent gain in July, as 17 of the 20 cities tracked recorded price increases.

While no one is predicting dramatic increases in sales or prices in the near-term, “the sustained good news in home prices over the past five months makes us optimistic for continued recovery in the housing market,” David Blitzer, chairman of the S&P index committee, said in a press statement. And it appears that more analysts are beginning to share that view, forming a growing consensus around this optimistic assessment by Russell Price, a senior economist at Ameriprise Financial. “The recovery in housing is real,” he said, “and it is sustainable.”