The US economy is slowing as the hypercyclical housing sector is rolling over with the current new housing inventory of 480,000 at levels approaching the great financial crisis peak of 580,000. There now is 9 months of supply of new housing vs. a recent average of 6 months and a GFC peak of 12 months. The most recent housing start data was weak at 1.36MM units down from recent averages above 1.5MM. The average recession resulted in a decline in housing starts to 900,000 and a low of 500,000 during the GFC. A decline in the interest-sensitive housing and auto sectors in response to Fed tightening has caused 12 out of 12 post-WWII recessions.
We continue to believe that inflation is almost exclusively driven by excessive monetary growth and supply shocks as the price level approximates the ratio of money to total goods and services over time ("the quantity theory of inflation"). The US money supply has only grown 5% over the last year, which is in line with nominal GDP growth so should not contribute to inflation. Moreover, energy prices have declined by over 15% within the last month, which should result in a decline in 2nd quarter reported inflation.
We expect that the combination of the decelerating economy and cooling inflation sets the stage for a Fed rate cut in July or September. The fact that the ECB is likely to cut in early June will also be deflationary as the dollar is likely to appreciate which lowers the prices of imports and commodities. The Fed continues to believe that the labor market is the key source of inflation ("the Phillips Curve theory of inflation") despite the fact that the theory led to the disastrous "transitory" call. Therefore, the Fed is not likely to cut rates until there is a clear slowing of the economy and the job market. We forecast that the slowdown will become more evident over the next couple of months and will force the Fed to cut rates by September.
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