New York, NY, Wednesday, July 5th [6 min read] ~ We have asserted over the last year that we believe the US is unlikely to enter a recession and continue to believe that we are not going to enter a recession in 2024. This outlook is controversial as we currently have an inverted yield curve which indicates very tight monetary policy.
In 11 out of 11 post WWII recessions, there were significant tightening of monetary policy with 7 of the 11 recessions resulting in a yield curve inversion. Rising long term interest rates and the tightening of monetary policy causes a significant decline in the housing market. The average recession produces a decline in housing starts (new construction) of 940,000 or 48%. The worst decline was during the Great Recession, a 79% decline (1.74MM).
The decline in housing starts results in mass layoffs in the construction sector with an average job loss of over 14%, representing almost a 1MM job loss, with the great recession experiencing a 2.3MM job loss or a 29% decline. The decline in construction also leads to a reduction of manufacturing jobs as consumer durable demand is primarily driven by housing construction (and is negatively impacted by higher interest rates as well). The mass layoffs from the housing and consumer durables sectors result in a reduction in consumer demand from laid off workers and ripples though the rest of the economy.
We believe that this Fed tightening cycle is different due to post Pandemic tailwinds. Specifically, we currently have a shortage of both homes (see chart below) available for sale and auto inventories. There are currently only 1.5MM new and existing homes for sale vs. a normal level of over 2MM and the inventory of autos for sale is only 150,000 vs. a normal level of almost a million units. This shortage is keeping both housing construction and auto production stable despite historically high interest rates. In addition, construction employment just hit an all-time high of 7.9MM with annual spending of over $18 trillion. We expect construction employment to remain robust as construction is supported by government spending from the infrastructure bill, the CHIPS Act, the IRA and the ARPA. We estimate that government financed infrastructure will add over $200 billion of construction expenditures per year and offset potential weakness from commercial construction in response to a reduction in demand for office space. In addition, the ongoing shortage of service workers, stemming from the Pandemic, is keeping employment growth strong, further supporting the economy.
PCE Decelerates Putting Pressure on the Fed to Pause
PCE decelerated in May with Headline coming in at .1% and Core at .3%, which was in line with expectations and down from .4% in the prior month. Shelter costs continued to lag the actual economy by coming in at .5% for the month despite the fact that both housing prices and rents are declining. Year over year headline came down to 3.8% and Core down to 4.6%. Our PCE-R index, which utilizes housing prices to estimate shelter inflation came in at .3% for the month and 2.6% Y/Y.
We believe that the Fed will come under intense pressure to yet capitulate on their “Entrenched” theory of inflation by pausing at the July meeting as data continues to verify that inflation is rapidly declining and the economic growth is slowing.
We project that the June inflation data will plunge to a Y/Y rate of 3.1% for CPI, zero for PPI and only 1% for CPI-R, which is the InfraCap real time core CPI index. In addition, PCE-R is likely to come in very close to the Fed’s target of 2%. PCE-R clearly demonstrates the fundamental flaw of this Fed, in that it continues to follow its discredited Phillips Curve framework for predicting inflation and ignores leading indicators of inflation such as the money supply, housing prices, energy and commodity prices, and real time indicators such as PPI and CPI-R and PCE-R. Moreover, the Fed also fails to correct its lagging PCE core number for the fact that the shelter component is not an accurate measure of actual shelter inflation.
There are a few members of the committee, such as Austan Goolsbee of the Chicago Fed and Raphael Bostic of the Atlanta Fed, who have made it clear that they reject the Phillips Curve framework and favor a pause to further assess the damage to the regional banking sector and economy that the Fed’s overly aggressive tightening has brought. We believe that the inflation data that comes out before the Fed meeting in July will give them ammunition to potentially head off an ill-advised rate hike, despite the signaling by the Fed Chair that one or two more hikes are likely.
* The opinions represented above are subject to change and should not be considered investment advice. This data was prepared using sources of information generally believed to be reliable; however, its accuracy is not guaranteed.
** Housing Chart Data - This data was prepared using sources of information generally believed to be reliable; however, its accuracy is not guaranteed. Opinions represented are subject to change and should not be considered investment advice. The comparative data is provided for information purposes only and should not be relied upon for making comparative investment decisions.