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Weekly Update 6/24/2022: Fed Chairman Powell Continues Inflation Fighting

  • Housing data released
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During his testimony on Capitol Hill, Federal Reserve Chairman Jerome Powell made it clear that the Fed is all about fighting inflation. The biggest risk today in his opinion is “that we would allow this high inflation to get entrenched in the economy. We can’t fail on that task. We have to get back to 2% inflation.” He added: “Inflation has obviously surprised on the upside over the past year, and further surprises could be in store. We therefore will need to be nimble in responding to incoming data and the evolving outlook.” The tone of his prepared remarks as well as his response to questions from Congressional members showed that the hawkish bent made at last week’s Federal Open Market Committee meeting is here to stay for the foreseeable future.

While achieving a soft landing—whereby inflation cools but the economy does not dip into a recession—is the goal, Powell acknowledged the challenge. “The events of the last few months around the world have made it more difficult for us to achieve what we want. We’ve never said it was going to be easy or straightforward,” he commented. While a recession is possible, it is certainly not the intended income of the Fed. For investors, the key phrase is “compelling evidence” that inflation is moving lower. While Powell does not quantify exactly what that means, it certainly is not price levels at some of the highest levels in the past four decades. The Fed is trying to get inflation back down to around 2% but it is hard to steer a $24 trillion economy with a blunt instrument like rate hikes. When questioned if the Fed needs more (or better) tools, Powell said that rate hikes are good at blunting aggregate demand but is insufficient for dealing with volatile components like food and energy. He said it is up to Congress to provide other tools so the Fed is powerless in that regard. Even if prices move down to 6% or 5%, does that mean the Fed should stop hiking? Maybe that is not enough and prices will pop back higher. Or, if it continues to boost its benchmark rate, it may overshoot on the downside and trigger a collapse in demand and recession. That is why the Fed cannot just raise rates willy-nilly in response to every single data point—it would cause utter chaos in the markets and may not even achieve their target while certainly leading to a recession if done to an extreme. As we have been saying for some time now, it is a process which is going to require patience.

Economic Data

We received a number of housing related economic data items this week. According to the National Association of Realtors, sales of previously owned homes fell for a fourth consecutive month in May. Contract closings declined 3.4% in May from April to an annualized rate of 5.4 million, the weakest since June 2020. Though that was in-line with the median forecast in a Bloomberg survey of economists, it is a worrisome sign that this part of the market has shown considerable weakness in response to the spike higher in mortgage rates. The number of homes for sale fell from a year ago, to 1.16 million. While historically low, that marked the fourth straight month of improvement in months’ supply. The median sales price rose 14.8% from a year earlier, to a record $407,600. Cash sales represented 25% of all transactions, up from 23% in May of last year, as cash buyers are less sensitive to mortgage rates. Nevertheless, affordability issues remain a headwind as first time buyers accounted for 27% of sales last month, down from 31% a year ago.

New home sales data released today by the Census Bureau and Department of Housing and Urban Development showed an increase of 10.7% in May versus April. The figures for April were also revised upward. The median price for a new home rose 15% to $449,000. At the current pace, it would take 7.7 months to exhaust the supply of new homes. That compares with 8.3 months in the prior month and 5.4 months one year ago. Existing homes sales are tallied when the transaction closes which may be weeks after a deal is reached. In contrast, new home sales are recorded as soon as the contract is signed providing a bit more of a timely residential market indicator. New home sales comprise only about 10% of the market but are an important indicator in the trend and temperature of the market. Many of the existing homes sold were done weeks ago when mortgage rates were lower which suggests that upcoming transactions will be slower and harder to close. The only reliable conclusion is that housing demand remains mixed and very sensitive to rate moves.

In a bit of good news for the Fed’s inflation fighting, the University of Michigan’s final June reading of longer-term consumer inflation expectations settled back from an initially reported 14-year high. Respondents said they expect inflation to rise 3.1% over the next 5-10 years, down from a preliminary report of 3.3%. They see prices rising 5.3% over the next year, however, emphasizing the upward momentum in the short-term. This report played an important role in the Fed’s decision last week to raise rates by 75 basis points (0.75%) rather than the 50 basis points many Fed governors had been emphasizing for weeks prior to the Federal Open Market Committee meeting. Powell, at the post-meeting press conference, said the preliminary data was “quite eye-catching” and may have flipped the decision for some committee members. The University survey was not all good news as about half of the respondents expressed “bleak views” about the risk of a recession and rising unemployment. The Fed’s next meeting is the last week in July and there will be plenty more economic data to chew on before then.

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