This week, the S&P 500 fell 3% in response to data that showed the economy is resilient, but inflation remains stubbornly high. Although a strong economy is usually celebrated, this combination of factors will likely prompt the Federal Reserve to raise interest rates higher than previously anticipated.
Tuesday - Monthly Existing Home Sales report from the National Association of Realtors, showing existing home sales have declined for twelve consecutive months.
Take Away - Most existing homeowners who have mortgages have interest rates under 4%. To sell their existing home and buy another would require them to buy a home that may cost more than their current home and finance it at a higher rate.
Tuesday – The weekly gasoline report from the Energy Information Administration report showed prices ticked down slightly this week but above the longer-term average.
Take Away – Growing economies require more energy. When the US economy reopened after the pandemic, we saw a spike in gas prices as demand grew faster than supply. A sudden spike or drop in gasoline prices could indicate changes in economic activity.
Thursday – According to Freddie Mac, the 30-year mortgage rates increased to 6.5% this week after falling earlier in the year.
Take Away – The Fed is trying to reduce inflation by slowing demand. Housing is a significant contributor to inflation, and the Fed is raising the cost of money to slow the demand for housing. I expect mortgage rates to follow as the Fed Funds rate rises.
Thursday – Weekly Initial Claims for Unemployment Insurance were 192K, lower than the previous week.
Take Away – There have been lay-off announcements, but they have not translated into claims for unemployment insurance. This could be due to generous severance packages or those being laid off from one company are quickly finding new employment. The Fed is trying to reduce inflation by slowing demand, including labor demand. Data that suggests that inflation remains high and the labor market tight will lead to the Fed further tightening monetary policy.
Friday - New Home Sales were up 7.2% in January month over month but still down 19.4% year over year.
Take Away – In the years leading up to 2007, homebuilders overbuilt. During the Great Financial Crisis, many homebuilders were left with homes they couldn't sell. Since the Great Financial Crisis, new home construction has lagged demand as homebuilders have been reluctant, fearing a repeat of earlier mistakes.
Friday – One of the Fed's preferred measures of inflation is PCE (Personal Consumption Expenditures). Core PCE excludes food and energy, not that food and energy aren't important; it's that food and energy are more volatile, and excluding them gives a clearer picture. The January report showed that inflation moved higher month over month.
Take Away – Reviewing statements made during the press conference following the last Fed meeting; I don't think higher inflation is what Chairman Powell expected. If the data we get between now and the next Fed meeting in March shows inflation continues to increase, we could see the Fed become more aggressive in its approach.
I believe we are in or on the cusp of a recession. An inversion of the yield curve between the yield on the ten-year Treasury Bond and the two-year Treasury Bond has often preceded recessions, and this part of the bond yield curve is the most inverted since 1981.
Interest rate traders have been increasing expectations for how high the Fed Funds rate will go. Currently, traders are pricing a 0.25% rate increase at the following three Fed meetings and remaining above 5.25% for the remainder of the year.
