Viewpoint
October 25, 2024 | 14:17
October 25, 2024
The Calm before the Storm? |
The economy is strong with only eleven days until Election Day though one wouldn’t necessarily know it given all the complaints about inflation and other negative attack ads on the economy. The growing economic and financial angst is hard to miss in recent consumer confidence data. The Conference Board’s Consumer Confidence Present Situation Index has been on a steady slide since the beginning of the year and the decline appeared to accelerate in September. It has slid over 30 points in the past eight months—the largest drop since the pandemic—and is now nearly 50 points below pre-pandemic levels (Chart 1). In short, consumers aren’t feeling it. |
The Fed’s Beige Book, a summary of economic activity, labor market and inflation anecdotes from the twelve regional Federal Reserve Districts, has taken on a far more somber tone on economic growth. Most districts reported economic activity was little changed since September, while reports on consumer spending were mixed. Hurricane damage impacted crops and paused business activity and tourism in the Southeast. Agriculture was flat or down modestly as some crop prices remained unprofitably low. Energy was weak as lower prices compressed producer margins. The news on inflation, however, continues to improve with selling prices reportedly increasing at a slight or modest pace in most Districts. These downbeat reports notwithstanding, most U.S. economic data, both ‘hard’ indicators like retail sales and employment, and ‘softer’ survey measures of sentiment and PMIs, continue to defy expectations of a sharper downturn. Positive economic surprises are actually becoming much more frequent after hitting a low back in July (Chart 2). Better-than-expected job, earnings, and retail sales growth for September, along with a big improvement in the U.S. trade deficit in August, helped bolster our third quarter GDP growth estimate to 3.0% a.r. from prior expectations for a 2.2% growth pace. We expect solid growth in nearly all major categories of domestic aggregate demand: real consumer spending, business equipment and software spending, and government spending. If realized, that would mark two back-to-back quarters of 3.0% GDP growth and keep the yearly rate at a robust 2.7%, demonstrating that the U.S. economy continues to outperform its potential long-term growth rate of around 1.9%. |
All this is spectacular economic news, but the fourth quarter is bound to be a bit rougher around the edges, slowing to around a 2.0% annualized pace. Investors and consumers need to be prepared for more near-term economic and financial market turbulence. Already, there is more uncertainty than usual around the October Employment report, released next Friday. The impact of two hurricanes and the Boeing and East Coast port strikes muddies the economic and inflation waters, making the right decision on future rate cuts all the more difficult for the Fed. We are forecasting a 140k job gain in October, down from 254k in September, with the unemployment rate holding steady at 4.1%—but also acknowledge the higher-than-usual uncertainty surrounding those estimates. |
Additionally, longer-term interest rates have been volatile and generally trending higher over the past month as the election approaches and even as the Fed eyes further rate cuts. This threatens the nascent housing market recovery and overall loan demand. Mortgage purchase and refi applications have been cut off at the knees, plunging 11% and 40% from a month ago, after initially surging on the Fed’s 50 basis point rate cut (Chart 3). Finally, prolonged election outcome uncertainty, and the potential for dramatic changes to federal tax and spending policy next year, could hold back business and consumer spending and confidence until the fiscal path forward becomes clearer, no doubt adding to the drag from a still-restrictive monetary policy. |
The Bond Market’s Autumnal Angst |
The days before the FOMC’s last confab (September 18) marked the 16-month low for 10-year Treasury yields at under 3.65%. During the past five weeks, yields have backed up to hover just under 4.20%. Altered Fed policy expectations have been the major factor prompting the sell-off. Immediately after the surprising 50 bp rate cut, the (OIS) market was pricing in 72 bps of further easing for this year, which meant very high odds of a matching 50-bp action. This was followed by a bit more than five 25-bp cuts by the end of next year. Currently, the market is pricing in only 42 bps of easing for the rest of this year, not even two complete quarter-point actions. For next year, the market now expects a little less than four moves. Indeed, it now pegs the year-end levels for the effective fed funds rate at slightly above what’s implied by the FOMC’s median projection (range midpoints of 4.375% for end-2024 and 3.375% for next year). The interim flow of surprisingly sturdy economic indicators has convinced participants that a data-dependent Fed was unlikely to ease as aggressively as initially assumed. For example, September’s employment report showed a second consecutive one-tenth dip in the jobless rate (to 4.1%), with both payroll and household employment growth posting six-month highs (254k and 430k, respectively). September’s CPI report showed a second consecutive pair of at least 0.3% monthly moves for the core and supercore indices. This pushed their three-month annualized changes from around a perfect 2.0% to above 3.0%. And, retail sales revved in the month, clocking 0.7% m/m (ex. autos & gas), which was also the control metric’s clip that feeds directly into PCE. The occasion caused us to lift our forecast for annualized real GDP growth in Q3 to a Q2-matching 3.0%, from 2.2% previously. However, the data flow has not been the only item increasingly on the market’s mind. With November 5 fast approaching, political and post-election policy uncertainty has been mounting. The latest projection of the cumulative budget deficit from the current fiscal year (which began this month) through 2034 is $22.1 trillion, according to the Congressional Budget Office (CBO). During the campaign, both presidential candidates have proposed new policies that are going to bloat the CBO’s already bulky baseline. According to the Committee for a Responsible Federal Budget, the 10-year price tags for these policies and promises run at $3.5 trillion for Ms. Harris and $7.5 trillion for Mr. Trump. To see either of these plans unfold, the victorious candidate’s party would of course have to score majorities in both the House and Senate. Market participants may be hoping for a divided congressional outcome, but they are planning for further meaningful fiscal deterioration no matter who or what party wins. The authors of 2017’s Tax Cuts and Jobs Act knew full well that when it came time for its personal tax cuts to expire (January 1, 2026) the government of the day would have a tough time allowing this to happen for most if not all Americans. According to the CBO, fully extending all expiring measures (tax cuts and others) would cost $3.4 trillion through 2033. This would be shaved to the extent the tax cuts were not extended for all (say, not for rich folks). Simply put, regardless of the results on November 5, the supply of Treasuries is about to balloon and participants are seeing lower market-clearing prices (or higher yields) in the cards. |
All Quiet on the U.S. Housing Front |
We last wrote about the soggy housing market in the spring, expressing a lack of optimism for a quick recovery. And, the market has only weakened further since then. Existing home sales fell for a sixth time in seven months in September to the lowest level in 14 years and 30% below pre-pandemic levels (Chart 1). |
The much smaller new homes market is doing better than the resale market, with sales jumping to a 17-month high in September. That’s partly due to greater availability—a 7.6 months’ supply versus 4.3 in the resale market, and resulting lower prices this year. Home builders are more eager than owners to cut a deal. Owners with sweet pandemic-low mortgage rates are hunkering down, reluctant to move and risk refinancing at today’s higher levels. The effective mortgage rate for current owners is tucked below 4%, compared with 6.5% for the current 30-year fixed mortgage rate. Lack of affordability, rather than availability, is the greater challenge for the market. Simply put, it’s far cheaper to rent than buy, with rent increases cooling faster than prices this year. The median rent on new apartment leases fell 0.7% y/y in September as apartment vacancy rates rode a wave of construction higher. Meantime, although earlier heated price gains have cooled, they’re still outpacing family incomes. Median resale prices rose 3.0% y/y in September, while disposable personal income per capita is running in the 2½% range. Some earlier progress on affordability has partly reversed due to a recent back-up in bond yields, keeping it near generational lows. While the effective 30-year fixed mortgage rate is down from last year’s 23-year high of 7.8%, it’s still more than one percentage point above levels that are likely to attract prospective buyers. |
Understandably, home builders are cautious, with the NAHB index holding in contraction territory for a sixth straight month in October. Although housing completions remain high, that’s largely due to the large pipeline of condos that were started in a friendlier rate climate, notably in the South. Units under construction are now falling fast as housing starts have returned to more normal pre-pandemic levels. There aren’t many soft patches in the U.S. economy right now, but the housing market is one of them (along with manufacturing and office construction). Fed easing will support a recovery, but don’t expect a snappy rebound anytime soon. |