Economic Data Tracker – 
Housing slump challenges inflation narrative

Economic Data Tracker

April 19, 2024

Our weekly view on the economy including rationale on GDP, jobs report, and Fed policy decisions. Download the entire weekly edition to view timely charts and data providing a comprehensive picture of how incoming economic data affects our economic outlook.

Trend watch

Initial data indicates that some freight is successfully being diverted from Baltimore. For instance, the Port of Brunswick (Georgia) saw the number of units for roll-on/roll-off, such as automotive and heavy machinery, jump 21% compared to March 2023 resulting from a 27% increase in the number of vessels. Both are all-time records for Brunswick.

Additionally, the nearby Port of Virginia, which includes Norfolk and Newport News, saw a 3.5% jump in container traffic in March. That’s up 17.2% from March 2023. However, those figures don’t capture some of the largest volume sectors for Port of Baltimore; most notably, bulk cargo such as coal and metals. Moreover, the March data only encompassed a few days of diverted traffic as the F.S. Key Bridge accident occurred on March 26th.

Most of the activity-based indicators (slides 5 and 6) improved this past week compared to the softness in March around the Easter holiday. 

What’s new this week

  • Retail sales hit new all-time high (slide 7).
  • Existing home sales drop in March, but prices ticked higher (slide 8).
  • New housing activity stumbled in March (slide 9).
  • Industrial production climbs as automotive production nears all-time high (slide 10).
  • Leading indicators slump in March, but annual change improved again (slide 11).  

Our take

There’s been a lot of ink spilled of late discussing inflation – everything from the causes to remedies. Many have opined that it’s “all about interest rates” and, thusly, put the onus for economic growth on the Federal Reserve (Fed) since they’re the folks that “control rates.” If only it were that easy. 

Indeed, interest rates are a critical factor for economic growth. But interest rates are far from the only factor. Moreover, the Fed mostly just controls overnight rates, the so-called front end of the yield curve. For instance, the Fed doesn’t set rates for mortgages, auto loans, credit cards, etc.; those rates are controlled by markets and lenders. To be fair, though, the Fed has also impacted other parts of the curve in recent decades with quantitative easing and now quantitative tightening.

Furthermore, the Fed doesn’t control the factors of production in the economy. While it does heavily influence the cost of capital, the Fed doesn’t control lending, land, labor, or other resources.

Which brings us to inflation. The late, great economist Milton Friedman famously said, “Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” And since the Fed controls the quantity of money – it MUST be their fault, correct? It’s not that simple.

Friedman wasn’t wrong about the role of monetary policy – controlling interest rates – and its impact on long-term economic growth. But he also strongly espoused the forces of supply and demand, which is conveniently ignored by those that wish to pin the blame for all that ails the U.S. economy on the Fed.

With respect to inflation today, the biggest issue is housing, not the money supply, which has been shrinking dramatically since December 2022 on a year-over-year basis. While prices generally have increased, the stickiest component of the Consumer Price Index (CPI) has been housing, which comprises just over 45% of CPI. There is a lack of supply of housing units, both single- and multi-family, after nearly 20 years of underbuilding following the double-whammy of popping the housing bubble and the Great Financial Crisis. (Other CPI components remain elevated too, but housing is the biggest issue.)

Depending on the source, the U.S. is estimated to have a deficit of 2.5 to 7.5 million housing units. That is further impacted by the dearth of existing homes for sale, though this is partly impacted by the Fed as interest rates have dramatically risen during the past two years.

Accordingly, with a massive lack of supply, home prices and rents remain well-above pre-pandemic levels, which is keeping inflation elevated. And the housing supply isn’t going to be fixed anytime soon.

While it seems counterintuitive, the Fed could actually help this housing supply issue on the margin by lowering rates a bit. First, modestly lowering interest rates would reduce mortgage rates, which are currently hovering in the mid-7% range. That would help spur new homebuilding and perhaps unblock some of the logjam of existing home supply, both of which would assist in reducing home prices and, in turn, cool the housing component of inflation. Secondly, it would definitively signal to skeptical markets that the Fed isn’t going to hike rates in the near term. 

Thus, we maintain our view that the Fed will reduce rates in the summer, which would ease financing pressures on consumers and businesses alike. Also, simply reducing interest rates slightly wouldn’t be accommodative monetary policy. In other words, lowering the Fed funds target rate to say 5% would still be restrictive. That is much of the reason why the Fed doesn’t have to wait until inflation moves all the way down to its 2% target, along with considerable lags between when the Fed raises/lowers interest rates and when it fully impacts the economy. 

Bottom line

The U.S. economy remains resilient and should sidestep a recession. Most economic data continues to steadily improve. Yet, the cumulative impact of higher rates does weigh on economic growth. We maintain our view that the Fed will reduce rates in the summer. 

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