Employment Report Disappoints but Probably Won’t Delay Federal Reserve’s Tapering Plan

The September employment report disappointed analysts; will it also complicate the Federal Reserve’s plan to begin withdrawing the monetary support that has cushioned the economy throughout the pandemic?

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“Patience” was the byword for the Federal Reserve, driving a unanimous decision by the policy-making Federal Open Market Committee to stand pat on interest rates for now, and producing a decidedly less hawkish tone in the statement released after the committee’s January meeting.  

“In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes,” the statement said.

Although not surprising in light of recent developments – the 34-day government shutdown and stock market turbulence among them – the Fed’s decision did mark a notable shift from concern about an overheating economy, to concern about risks to economic growth.

The Federal Reserve hiked its benchmark interest rate four times in 2018 and until recently, had been signaling the likelihood of as many as three and possibly four rate increases this year.  Analysts are now predicting no more than two hikes in 2019 and some think the Fed may not boost rates at all. 

Confirming a more cautious approach to  monetary policy, Federal Chairman Jerome Powell told reporters after the FOMC meeting:  “We are now facing a somewhat contradictory picture of generally strong U.S. macroeconomic performance alongside growing evidence of cross-currents. Common sense risk management suggests patiently waiting greater clarity.”

Confounding the Fed’s decision, employers added 304,000 workers to their payrolls in December, as the shutdown proved far less of a drag on the labor market than feared.  Employment gains for the year were the strongest in three years.

Warning Signs

Concerns about the economy have been mounting since the Fed approved its fourth rate increase of 2018 in December:

  • The rate of economic growth slowed at year-end, falling below the 3 percent pace maintained through last September.
  • The government shutdown is expected to shave $3 billion – between 0.3 percent and 0.4 percent – off the first quarter growth rate, already expected to slip below 2 percent.
  • The ongoing trade war (which has produced the steepest decline in China’s economic growth rate in nearly three decades) has led many American businesses to curtail expansion and investment plans – further dampening the growth outlook for this year.
  • Although consumer spending – the primary engine driving U.S. economic growth - remained solid for most of last year, growth in retail sales has slowed, and consumer confidence has been declining since November. The University of Michigan’s confidence survey fell to its slowest level in nearly two years in January.

“There are good reasons to expect growth to be slower in 2019 than 2018, Jim O’Sullivan, chief U.S. economist at High Frequency Economics, told the Wall Street Journal. “The question is how much.”

Most analysts still see enough underlying strength in the economy to sustain the expansion, which is close to becoming the longest on record.  Diane Swonk, chief economist at Grant Thornton, is in that camp.  “The economy is slowing but not enough to derail the expansion,” she told the Journal.  But she is not sanguine about the outlook.  “The bad news is the straws on the camel’s back are really piling up,” she noted,  “and the back’s beginning to bend.”

Housing Plunge

The housing market is a particularly large straw. Existing home sales cratered in December.  That may sound extreme, but the terms that have described this slowing trend since May – “fell,” “slipped,” “dipped” and “declined” ─ don’t convey the 10 percent year-over year difference in sales for the final month of the year.  That’s the steepest annual decline in more than seven years, and it followed back-to-back declines of 7.8 percent and 5.1 percent in November and October, respectively. Pending sales, an indicator of future transactions, also declined in December, for the 12th consecutive month.

Despite those hard-to-ignore negatives, Lawrence Yun, the NAR’s chief economist, thinks conditions will improve this year – primarily because, with the Fed’s recent shift in policy direction, the interest rate outlooks is now more favorable.  Interest rates, which declined  unexpectedly at year-end, are now likely to remain low and possible fall further, Yun predicts.   “Rather than four rate hikes, there will likely be only one increase or even no increase at all,” he told reporters recently. “This has already spurred a noticeable fall in the 30-year, fixed-rate for mortgages,” he noted. “As a result, the forecast for home transactions has greatly improved.”

The prospect of lower rates has also made home builders more optimistic. Builder confidence levels, measured by a National Association of Home Builders index, increased by 2 points in January, after steep declines in November and December had left the index at its lowest level in more than two years.

Whether that more positive mood is sustainable is open to question, however.  New home sales for November rebounded from an October decline, but still fell 7 percent below the year-ago pace.  Separately, the Mortgage Bankers Association reported a 7 percent year-over year decline in that applications for mortgages to finance new home purchases in December, following a 13 percent drop in November.  And Zillow reports that builders reduced prices on about 25 percent of the new homes offered for sale last year in most of the nation’s largest housing markets.

Closing the Gap?

Existing home prices are still rising, notwithstanding slower sales, but the rate of increase has been slowing, boosting analysts’ hopes that lagging incomes may begin to catch up. The closely-watched CoreLogic Case-Shiller National Home price Index increased at a 5.2 percent annual rate in November – the slowest pace in almost six years. 

“It was like hitting the brakes when you’re going over the speed limit,” Redfin Chief Economist Daryl Fairweather told Bloomberg.com.  “You can’t have prices growing faster than wages year after year.” 

But he sees the slower appreciation rate as potentially good news, closing the gap between incomes and home prices, and giving affordability-strapped buyers more purchasing power. Lagging sales, meanwhile, will shift the negotiating balance in favor of buyers, who will  have more options from which to choose and feel less pressure to offer whatever sellers demand, the Redfin analyst reasons. 

While affordability pressures may be easing for some potential buyers, demand is emerging a potential question mark. Homebuying sentiment, measured by a monthly Fannie Mae survey, plummeted by 12 points in December, as the number of buyers who think it’s a “good time” to buy sank below the number who think it’s a good time to sell.  That is “a foreboding signal,” according to a recent article in Business Insider,” which notes that this has occurred only twice in the 26 years Fannie has been asking this question.  And both instances, the article notes “preceded our two most recent recessions.”