Fed rate hikes: Cause for pause?
Fed watchers see potential for a pause in rate increases, but recent reports show the economy still runs hot.
Last week’s economic data showed a rebound in retail sales, suggesting that consumer activity remains strong amid solid job and wage gains. Also, housing market data, while weak in an absolute sense, has stabilized after last year’s sharp declines and ahead of what could be a bumpy second half of the year for the industry.
The retail sales control figure, which excludes autos, gas, and building supplies, posted its strongest gain since January in April.
Existing home sales experienced a small decline in April, but sharp downward pressure on sales seems to have subsided for now.
New home sales unexpectedly spiked in March to the highest level seen in a year after some easing of mortgage rates offered stabilization in the housing market. Buyer interest in new homes continues to be driven by very low inventory of existing homes. There were large upticks in sales in the West, Northeast, and the Midwest regions which are unlikely to be sustained. April’s new home sales is expected to show some decline from March’s strength, slowing to an annualized pace of 665,000.
Prices are still rising at a brisk pace, but consumer spending has shown resiliency so far, driven by solid wage gains. Those trends should continue in April with personal spending expanding by 0.4 percent and personal income to increase 0.5 percent. Retail sales advanced strongly in April which should fuel personal consumption expenditures. Additionally, average hourly earnings grew solidly in April, likely providing households with some cushion for spending. However, consumers are increasingly relying on credit for purchases despite consistent increases in earnings — suggesting that spending could be slower going forward as households approach their limits.
Personal consumption expenditures (PCE) inflation continued to ease in March, reflecting decreases in energy prices and food inflation. However, the labor market showed further strength in April, surprising to the upside with widespread job creation and higher earnings. Moreover, energy costs bounced back in April and should lift inflation readings. The PCE Price Index should increase 0.3 percent for April while the core PCE should climb the same. This would keep the annual change in the core PCE elevated at 4.6 percent, still way too hot for the Fed.
The headline advance in April retail sales of just 0.4 percent came in softer than consensus forecasts, but the core readings posted strong increases. Retail sales excluding autos and gas were up 0.6 percent and core retail sales (which excludes autos, gas, and building materials) jumped an impressive 0.7 percent — roughly double the median gain. Even after adjusting for inflation, growth in the core figure was 0.4 percent and suggests that spending regained some of its momentum after declines in February and March.
Perhaps the most perplexing aspect of the report was the decline in gasoline sales despite a jump of 3.0 percent in gasoline prices. Given the same level of driving activity, a rise in prices should produce a similar rise in sales, which suggests that April’s rise in prices caused drivers to pull back on their travel. Still, the combination of solid auto sales (a proxy for durable goods sales), the jump in core retail sales, and the likelihood of sales in the services sector remaining strong (the only services number in the report — sales at restaurants and bars — was up 0.6 percent) leads us to look for a robust gain in consumer spending for April. That would provide a strong starting point for real GDP growth in the second quarter; with an annualized gain of 2.5 percent expected.
The rebound in consumer spending, along with signs of faster wage growth, may lift the odds of another rate hike at the next FOMC meeting in mid-June. We still feel that a pause in rate increases is more likely, but the odds are slowly shifting upwards. Moreover, the Fed’s bias is still pointed toward more potential tightening in the near term, rather than the rate cuts being priced in by financial markets.
Existing home sales fell in April to a seasonally adjusted annual rate of 4.28 million units, in line with consensus expectations. The decline illustrates the continued squeeze in the supply of existing homes as the current inventory of homes for sale fell to a 12-month low on a seasonally adjusted basis.
In addition to the limits put on sales by the very tight supply of existing homes, mortgage rates also hit a four-month high in March (when most of April’s sales would have gone into contract), driving up costs for potential homebuyers. The median price of a single-family home sold in April also rose, but this seems to be a function of location as smaller declines in sales were seen in the more expensive West and Northeast regions than in the South and Midwest.
Elsewhere in the housing market, housing starts climbed in April to an annual rate of 1.40 million units. The persistent dearth of existing home inventory continues to put pressure on builders, which has helped lift the pace of home construction. April’s faster pace of starts was driven by increases in both single- and multifamily starts, the latter of which continues to be far above its long-run average. Starts would likely be higher if not for the labor shortage in construction, the effects of which can be seen in the record length of time to take a started home to completion as well as the near-record level of homes under construction. On the upside, home builders are seeing improved market conditions, with increased foot traffic and higher expected sales over the next six months.
Both existing sales and starts seem to have found some stability so far in 2023 after the sharp declines seen last year. However, substantial relief on mortgage rates is not expected for some time, while the pending recession in the second half of the year should reduce homebuyer demand and keep both sales activity and home construction subdued.
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The economic and market forecasts reflect our opinion as of the date of this report and are subject to change without notice. These forecasts show a broad range of possible outcomes. Because they are subject to high levels of uncertainty, they will not reflect actual performance. We obtained certain information from sources deemed reliable, but we do not guarantee its accuracy, completeness or fairness.
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