After a topsy turvy year of high inflation and the Fed fighting it through rate hikes, I think we all thought - or at least hoped - the worst was behind us. In November mortgage rates peaked at just above 7% but then as inflation receded, rates receded right along with it. All through December and January we saw rates gradually dropping - not much mind you, but enough that everyone could build a little optimism after a rough year! I mean, we all know inflation has to come down but we want to see a soft landing - inflation coming down without a recession. Well last month’s numbers were just released and the threat of recession just went from bad to worse.
Well the numbers are in and our goose just might be cooked. We in the housing market - we’re not complicated. We just want a healthy, affordable real estate market, right? But to get there we’re having to navigate this bumpy road of inflation statistics, interest rate hikes and unaffordability. And this month’s numbers did not help.
Why is that? Well, believe it or not, last month’s economic data looked too good and we’re going to talk about that today. Specifically, we’re going to dig into the personal consumption expenditures index that was just released. This is the Fed’s baby, their preferred source of data. The Fed also relies heavily on the Consumer Price Index and Unemployment so we’re going to explore that as well. We’ll see what the experts have to say and discuss why these numbers just brought the risk and reality of an incoming recession from bad to worse.
The Numbers
You know, I am first and foremost a real estate broker but we talk a lot about the housing market on this channel because I feel like in order for you to make the best decision as a homebuyer you need to have an understanding of what’s going on in the market. For example, you might be wondering why in the world good economic news could be bad news for a homebuyer.
Well, Andrew Kelly with Reuters gives us a good explanation of that. He reports that “U.S. consumer spending rebounded sharply in January amid strong income growth” Yea! Great news right? But no. He explains that this could “add to financial market fears that the Federal Reserve could continue raising interest rates through summer.” That’s where this catch 22 comes in. After the pandemic, runaway inflation caused home prices to run away right along with it. The Fed knows it needs to slow down inflation and we in the Dallas housing market certainly want home prices to slow down as well, but in order to accomplish that the Fed needs to see the economy contracting. We need to NOT see growth, we need to NOT see new jobs. And how are they going to be able to tell if that’s happening?
Well, the Fed uses multiple indexes to monitor the economy and inflation. We of course are more preoccupied with the Dallas housing market, but we keep our eye on those same indexes because especially now, what affects the economy affects our housing market. Unemployment and CPI are two big indexes the Fed uses but the Fed plays favorites and their top baby let us down this month so let’s talk about that first.
Greg lacurci explains that “The Federal Reserve prefers the Personal Consumption Expenditures Price Index to gauge inflation.”
Well that’s a mouthful
Yeah and also their favorite. He gives two reasons for this. He says it has a “broader scope and better reflects how consumers change what they buy to account for rising prices.” The PCE and CPI index essentially measure the same thing but they measure it differently with different priorities. The PCE updates their data more often whereas CPI tends to rely more heavily on lagging factors like shelter costs. Well, regardless of the reason this is the Fed’s baby and it did not behave last month.
Andrew Kelly explains that, “The personal consumption expenditures (PCE) price index, tracked by the Fed for monetary policy, shot up 0.6% last month after gaining 0.2% in December.”
Alicia Wallace observes that “The Federal Reserve’s preferred inflation gauge heated up unexpectedly in January, as did consumer spending, showing the continued strength of the US economy — and that rising prices won’t be so easily defeated.”
And remember, this is bad news! Jeffrey Roach, chief economist at LPL Financial explains why. He says, "This report all but insures the Fed will continue on its rate hiking campaign for a lot longer than markets anticipated just a few weeks ago.”
Well that is the last thing Dallas needs! Here on the homefront we’re struggling with unaffordability. Home prices became too high when interest rates were so low but now we have a double whammy of interest rates and homes prices both being too high.
Let’s check in with how the experts reacted to the PCE data. Brian Jacobsen, with Allspring Global Investments predicts “We'll probably see a reversal of these strong January numbers when the February numbers come out.”. He believes “this is more like a speedbump on the road to disinflation than a change in the trend.” So I’m over here saying Yes! I hope he’s right, which again is so counter intuitive and upside down.
Ken Mahoney with Mahoney Asset Management explains how the market as a whole responded to the PCE numbers. He says “the quick reaction is a major whoosh down”. He goes on to explain that the PCE numbers reflect “a spending surge and the Fed does not like that.” Well, let’s be real about this. With the economy the way it is, what the Fed doesn’t like we don’t like either.
Alicia Wallace is a little more graphic. She says “Stocks plunged on Friday morning as the PCE report’s numbers supported recent data that shows inflation isn’t falling at the pace investors had been hoping.:”
Gene Goldman, with Cetera Investment Management says “PCE numbers were well above expectations.” And He’s not saying this is a good thing either. He says, “What worries us most is that the data since the last Fed meeting has been extremely strong.”
Randy Frederick with Charles Schwab, Texas’s response was “the probabilities are quite high we're going to have three more quarter point rate hikes at the next three… meetings”.
Peter Cardillo with Spartan Capital Securities says "These are ugly numbers, and this is the Fed's preferred index, so we should expect hawkishness until the second half of the year."
In a nutshell, the general consensus on the PCE data from the experts was that it’s stronger than expected and will result in the Fed raising rates more than they expected.
So we know PCE is the Fed’s darling, and we know none of us particularly liked what it had to say this month, but if the Fed also considers CPI and unemployment we should touch on that as well.
When it comes to CPI, things had been looking pretty good towards the end of 2022. After encouraging numbers of .2% in November and .1% in December, January’s numbers came in higher than anticipated here too. Economists had been looking for increases of 0.4% which would equate to an annual gain of 6.2%. Instead they got .5% and an annual gain of 6.4%.
Elisabeth Buchwald explains that “On a month-by-month basis… prices increased by 0.5% in January compared with a slower gain of 0.1% in December.” So unfortunately, CPI reflected the growth we didn’t want to see there too.
Employment
In terms of employment, the jobs report released last month also greatly exceeded expectations. The prediction had been for a rise of 185k new jobs, but an astonishing 517k additional positions were revealed through business surveys and 894k from households. This pushed unemployment down to 3.4%, its lowest in nearly fifty years.
On the jobs front though, you really have to take a closer look to see if the numbers the BLS gave are really accurate. Out of 894k new jobs from the household survey - 606k of those jobs were part time. Households aren’t going to be able to make ends meet on a part time salary. There is no way this is the equivalent of the same amount of full time jobs. Plus a lot of people are working second and third part time jobs in addition to their full time jobs in order to make ends meet. Mitchell Parton gives you a lot of food for thought about this. He recently wrote an article in the Dallas Morning News entitled “How many minimum wage jobs do you need to work to rent in Dallas?”. He concluded, “in both Dallas and Fort Worth, it takes more than three full-time minimum-wage incomes for a person to comfortably afford the typical one-bedroom rental home”. To me that is such a staggering fact when it comes to measuring affordability in Dallas and of course this issue of part time jobs as well.
Another thing to consider when you see a lot of part time positions is that many companies will begin taking on part time positions when they are tightening their belts. It’s actually an indicator that companies are cutting back.
Secondly, the BLS got a little creative with the numbers. The Bureau made changes to their methodology with what’s named the ‘population control effect’. Thus, the job report numbers are artificially high because the weighting of how they calculated those numbers had changed.
And thirdly, unemployment typically rises only after a prolonged economic downturn. In other words, raising interest rates might slow an economy down, but that won’t be reflected in jobs data. You’ll have to be well into a slow down before you’ll see it reflected in a job report.
The International Monetary Fund even comments on this phenomena saying that, “At the start of a downturn, firms would rather reduce work hours, or impose some pay cuts before they let workers go. Unemployment starts rising only when the downturn is prolonged. Because unemployment follows growth with a delay, it is considered a lagging indicator of economic activity.”
So, lots of reasons the unemployment numbers may not be as remotely promising as they appear at first glance but at the end of the day all three metrics showed growth.
Bill Adam, Chief Economist with Comerica Bank in Dallas summarizes it this way. He said, “The takeaway is that the economy is still growing solidly. Total inflation rose more than expected, so this is a further sign that inflation is sticky in early 2023 making it more likely that The Fed would keep interest rates higher for longer.
Peter Cardillo follows that up saying, “The Fed is probably going to be more hawkish. Whether that translates to a 50 basis-point rate hike in March remains to be seen. But we are likely to see three more rate hikes.”
The Market
And really, that brings us to the point where we have to talk about over-tightening and how much this month’s data increases our odds of an even more severe recession. If you look at this chart you can see where the Fed’s target rate began in March and how much movement it carried just in 2022. Extending that into 2023, it has already raised rates by .25% additional points. Based on January’s data Cardillo predicts three more rate hikes with one of them possibly being a .5 hike.
I think this chart is really telling. You can see three major times the Fed has hiked rates in the past 25 years. In both 2000 and 2008 when they aggressively raised rates, each time resulted in a massive recession. If they were to raise as much as Cardillo suggests, by summer they will be at a targeted rate of 5.25 to 5.5. The last time they raised the rate that high triggered the great recession of 2008.
Kyla Scanlon describes it this way. She says “Right now, Jerome Powell is walking a tightrope. He’s trying to stick to a narrow path, and disaster looms if he strays from it.” She continues, “To one side of his tightrope is the catastrophe of high inflation” and to the other side “is the abyss of a hard recession.” She concludes that “Everyone knows what that means. The danger there is raising rates too high — carrying debt becomes expensive, everyone pulls back on their spending, and all of a sudden the economy is shrinking.”
I think the inconsistencies of the data are really frightening considering where we could land with the Fed continuing to tighten. Dallas is particularly vulnerable because we have a lot of underwater buyers right now. If a recession hits and we see unemployment skyrocket we’re going to see a corresponding wave of foreclosures that could crash the housing market. We talk about that in this video, which you may want to check out next.
