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Labor Market Continues to Generate Heat and Support for Federal Reserve’s Interest Rate Plans

To a summer that has been sizzling in many parts of the country, the Department of Labor’s July employment report delivered some additional heat. 

Employers added 209,000 workers to their payrolls, beating the consensus estimate and indicating that the nine-year-old economic recovery still has legs under it.

Revisions added 2,000 jobs to the May and June totals, the unemployment rate dipped a little and average hourly earnings – a source of ongoing concern for economists – increased by a respectable 2.5 percent year over year. 

A “Goldilocks” Report

“This is a Goldilocks report for the markets,” Michael Gapen, chief United States economist at Barclays, told the New York Times.  “It really bodes well for macroeconomic growth.”

The strong employment report also suggests that the Federal Reserve is likely to follow through on its plan to increase rates again this year and begin scaling back its bond portfolio.  

After implementing two consecutive interest rate increases (in March and June), the Federal Open Market Committee (FOOMC), the Fed’s rate-setting arm, hit the pause button at its July meeting, citing “realized and expected labor market conditions and inflation.” But the committee affirmed the plan to begin paring the Fed’s $4 trillion securities portfolio “relatively soon.”

 Some analysts have been predicting that the sluggish inflation rate, which remains below the Fed’s 2 percent target, may argue against another rate hike this year.  But if Fed officials are concerned about the lack of inflation, they haven’t expressed those concerns publicly.  In fact, the statement issued after the July FOMC meeting reflected confidence that continued labor market strength will produce the inflation they are expecting.   

Inflation Questions

“The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to two percent inflation,” the FOMC statement said.

Although the July employment gains seemed to provide some support for that view, the inflation indicators themselves haven’t yet begun to move.

Personal consumption expenditures, the inflation guide Fed analysts follow most closely, remained flat in June compared with May, which was also unchanged from April.  The June reading was up 1.4 percent compared with the same month last year, but that modest increase followed four consecutive year— over year declines since February.  Consumer spending and personal income didn’t move in June either – the first time in seven months spending hasn’t increased.   

Confidence – More or Less

Oddly, or maybe not so oddly, consumer confidence, measured by the Conference Board, hit a 16-year high in July, as consumers focused on the still-improving employment market and generally liked what they saw.

They were less encouraged about their personal finances. however:  The percentage of consumers expecting  their income to improve declined by almost one percentage point, and the share of those bracing for an income decline increased by about the same margin.

Given the persistent inflation lag, Andrew Hunter at Capital Economics sees “little appetite” at the Fed for another rate hike in September, notwithstanding the steady job gains.  But Fed Chair Janet Yellen suggested otherwise in Congressional testimony delivered after the July FOMC meeting. 

It is “premature,” she insisted to conclude that inflation won’t hit the Fed’s target.  “We’re not seeing very substantial upward pressure on wages [yet],” she conceded.  “But we may begin to see pressure on wages and prices as slack in the economy diminishes.” 

Housing Indicators

There is certainly no lack of upward pressure on home prices, which continue to reflect the impact of a severe inventory shortage. 

Although prices have begun to increase more slowly this year, the S&P/Case-Shiller index still jumped by nearly six percent year-over –year between March and May compared with the same three-month period last year.

Home owners have clearly benefited from that upward trend. Those who sold their homes in the second quarter booked an average gain of $51,000 – 26 percent over the original purchase price, on average, and the largest margin since the second quarter of 2007, just before the market crashed, according to statistics compiled by ATTOM Data Solutions.

But when these home sellers become home buyers, they run into the inventory shortage and rising prices that produced their record gains.  

Sales Decline

Industry executives blame the paucity of home listings for the unexpected decline in existing home sales in June.  The annual sales pace of 5.52 million units for the month was almost 2 percent below the May level and the second-lowest rate for this year.

“There’s no inventory, and that’s what’s really kicking the market in the teeth,” Nela Richardson, chief economist at Redfin, told the Wall street Journal. 

First-time buyers continue to struggle against these market headwinds.  They were responsible for just 32 percent of all purchase transactions in June, down only slightly from the previous month, but well below their historical average of 40 percent.

Pending sales, an indicator of future transactions, increased by 1.5 percent in June compared with May, posting the first year-over-year increase since March.  New home sales also managed a slim gain in June compared with May– but only because the May total was revised downward.  

Strong Demand – Weak Supply

“The demand for buying a home is as strong as it has been since before the Great Recession,” according to Lawrence Yun, chief economist for the National Association of Realtors (NAR), who told Housing Wire that listings priced affordably for entry-level buyers “continue to be scooped up rapidly.  But the severe housing shortages [affecting] many markets are keeping a large segment of would-be buyers on the sidelines,” he noted.

For first-time buyers in particular, Yun said, the home search will likely be “a strenuous undertaking” because inventory shortages in most markets “are most severe at the lower end of [the price range].”

The construction reports brought some hope of relief, as single-family housing starts and building permits both increased in June compared with May, indicating that builders are ramping up in response to increasing buyer demand, but not enough to make much of a dent in the inventory shortage. The 1.22 million annual pace recorded for housing starts in June remains well below the historical average   of 1.5 million, which is about where analysts say starts need to be to close the gap between supply and demand.

Builders, struggling with a shortage of labor and rising materials costs, don’t expect to hit that mark any time soon.  

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