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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“Disappointing.”  That’s a description that hasn’t applied to the U.S. employment growth in a long time.  But the Department of Labor’s August employment report fell well short of predictions, adding to concerns that the economy may be slowing and firming expectations that the Federal Reserve (Fed) will continue slashing rates in order to forestall what some see as a growing risk of recession. 

Employers added only 130,000 new jobs in August, and estimates for both June and July were trimmed by a combined total of 20,000 jobs.  Although the trend line for employment remains positive, analysts noted, the growth rate has slowed significantly, to an average monthly gain of 165,000 jobs compared with the scorching 223,000 average notched in 2018.  The unemployment rate remained unchanged at 3.7 percent – the lowest rate in almost  five decades ─  but average hourly wage gains, which have been unimpressive all year, fell slightly to 3.2 percent from 3.3 percent in July.

 “This miss in the jobs report tells us that a lack of confidence in the economy’s longer-term health is taking a sustained toll on business owners’ outlooks," Steve Rick, chief economist at CUNA Mutual Group, told NBC News. "And given the Fed’s rate cut in July, the looming pressure from tariffs, increasing market volatility and a middling international economic landscape, we’re starting to feel enough turbulence to justify their anxieties."

Lackluster Growth

The labor report wasn’t the only one that disappointed.  The economy grew at an inflation-adjusted rate of 2 percent in the second quarter, down from 3.1 percent in the first quarter. Manufacturing growth, measured by an Institute for Supply Management (ISM) index, slipped for the first time in three years, falling to 49.1 percent – below the 50 mark signaling contraction in this sector.

"It's not pretty, it's not something I like to see and it's a totally self-inflicted wound, so it's really dumb," Jared Bernstein, an economist with the Center on Budget and Policy Priorities, told NPR.  But while the manufacturing dip is disturbing, Bernstein said, “I don't know that it's recessionary at this point."

Joel Naroff, chief economist at Naroff Economic Advisors, Inc., agreed both with the concern about slowing manufacturing activity, and with the conclusion that it isn’t necessarily signaling a recession. “It is a warning sign,” however, he acknowledged, “and it’s  put a greater burden on the need for the consumer to keep spending and spending like crazy,” he told the Wall Street Journal.

Consumers Still Spending

Consumers, thus far, have been willing to oblige.  Retail spending increased by nearly 1 percent in July, according to a Commerce Department report, but consumer confidence, which has been consistently high this year, slid in August, falling from 98.4 to 92.1 – a seven-month low for the University of Michigan confidence index.  The measure of current expectations, though still high at 107.4, was the lowest it’s been in nearly three years; the view of future expectations was also weaker, at 82.3, down more than eight points since the July survey.

“Consumers concluded, following the Fed’s lead, that they may need to reduce spending in anticipation of a potential recession,” Richard Curtin, the survey’s chief economist, said in a press statement.

Investors are also worried.  The Wells Fargo/Gallup Investor and Retirement Optimism Index has fallen to 72, down 13 points from the second quarter and its lowest reading since the fourth quarter of 2016.

The accumulation of negative indicators is making many economists rethink their assumption about the resilience of the U.S. economy.  More than one-third (38 percent) of the economists surveyed by the National Association for Business Economics (NABE) expect a recession to begin next year, while 34 percent are predicting that a downturn will begin this year, 10 percent more than held that view a year ago.  Tariffs levied in the trade war with China and  rising government budget deficits are the major fears.

Sounding Alarms

The NABE survey looks relatively optimistic compared with some other forecasts. Ray Dalio, founder of the giant hedge fund, Bridgewater Associates, rates the odds of a recession beginning before the 2020 election at 40 percent. Echoing his concern, Chris Krueger, managing director of Cowen Washington Research Group, recently  advised  investors not to underestimate the negative implications of the continuing trade war.  “On a scale of 1-10,” he said, “it’s an 11.” 

Also striking something of an alarmist tone, Lawrence Summers, who headed the White House National Economic Council during the 2009-2010 financial crisis, said the trade war may have created “the most dangerous financial moment” the nation has faced since that time.   

Federal Reserve policy makes will be evaluating recession risks when the Federal Open Market Committee (FOMC) begins its next two-day meeting September 17.  The key question:  Whether to follow the quarter-point rate reduction announced in July with another one. 

Recent press reports have  provided a rare public view of dissension within the Fed’s ranks, with some Fed governors arguing forcefully for another rate cut, and others arguing with equal force that cutting rates is not only unnecessary, but could fuel an inflationary surge. 

Rates Move Home Sales

Mortgage rates, which have been declining for several months, have finally had an impact on home sales. Existing home sales increased 2.5 percent in July, rising to a seasonally adjusted annual rate of 5.43 million units. More significantly, July sales beat the year-ago total by 0.6 percent, reversing 16 consecutive months of year-over-year declines. 

The increase was “inevitable,” Lawrence Yun, chief economist for the National Association of Realtors, said, given the strong labor market and “incredibly low” mortgage rates.  The rate on a 30-year fixed rate mortgage stood at 3.77 percent in July compared with 4.46 percent a year ago, according to Freddie Mac.

But hope that the July increase in existing home sales might signal a market-wide rebound was dimmed by a 2.5 percent decline in the NAR”s pending sales index, reversing two consecutive monthly gains in that indicator of future sales, and suggesting to analysts that concerns about the economic outlook and a chronic shortage of homes for sale continue to undercut buyer demand.  

Builder confidence remains relatively high, hovering between 64 and 66 for the past six months in an index produced by the National Association of Home Builders (NAHB) and Wells Fargo ─ well above the midpoint (50) considered positive.  But builder optimism hasn’t been reflected in home starts, which posted their third consecutive monthly decline in July, falling by 4 percent overall.  Single-family construction inched up slightly, by 0.6 percent year-over-year, while permits increased by 1.5 percent – positive numbers but modest gains, analysts said, given low mortgage rates and rising incomes.  

“In theory, low mortgage rates combined with solid economic fundamentals…should be buoying the  housing market,” John Pataky, executive vice president of TIAA Bank, told Housing Wire.  “But the effects of this stimulus have been muted” in the new home market, he said.

Buyers Pulling Back

Some analysts don’t think additional rate-cutting by the Fed would have much of an impact.   The NAHB’s Housing Trends Report found that of the 12 percent of respondents who said they were “thinking about” buying a home in the second quarter survey, only 40 percent were actively looking for one – down from more than 50 percent in the same survey a year ago.  This suggests that lower rates “have not had the expected effect of nudging more people to start looking for a home to buy,” the NAHB report notes.

Affordability and economic uncertainty appear to be the primary impediments.  More than 50 percent of the respondents to the NAHB survey said high prices prevented them from buying compared with 45 percent in the previous survey.  More than half the prospective buyers responding to a  NAR survey said they intend to suspend their search until they feel more confident about the economic outlook.

Lower mortgage rates “could help on the margins,” Rose Quint, NAHB’s assistant vice president for survey research, notes in her commentary on the association’s recent survey.  But it is recessionary fears that are driving the call for further rate cuts, she notes, and those fears “outweigh the benefit [of lower rates] on a consumer’s balance sheet.  Buying a home is an incredibly emotional experience,” she adds, ”and potential buyers will often pull back when they have the slightest fear of losing their jobs or losing any income.”