June 26, 2023Scroll down
Stocks and bonds decline on hawkish testimony
Twice each year, the Fed chair visits Capitol Hill to provide testimony on policy developments to both chambers of Congress. Last week marked that semiannual report, giving Chairman Jerome Powell a chance on Wednesday and Thursday to further explain the US central bank’s decision to forego a hike at its June FOMC meeting. Stocks sold off ahead of Powell’s speech and continued to slide through Friday’s close on what was regarded to be a decisively hawkish message by the Fed chief, with the S&P 500 Index posting a -2.1% decline for the week and the Nasdaq Composite falling -2.6%. Treasury yields likewise increased across the curve. Powell reiterated the bank’s commitment to taming inflation with high rates, asserting that “the process of getting inflation back down to 2% has a long way to go,” and suggesting it was a “pretty good guess” the FOMC would put in two more quarter-point hikes by year end. On the question of whether a pause could mean rate cuts are on the horizon, Powell was particularly blunt in his response to the Senate Banking Committee on Thursday: “We don’t see that happening any time soon.”
Congress surprisingly welcoming toward Powell
Given how polarized politics has become over the last few presidential cycles and the aggressiveness of Fed policy over this monetary policy cycle, one might have expected members of Congress to take some shots at Jay Powell on behalf of their constituents. Indeed, based on a Pew poll from mid-March of this year gauging Americans’ views toward federal agencies, the US central bank received the second-lowest number of “favorable” responses among sixteen agencies on the questionnaire, just behind the least-loved IRS. The same poll showed that Republicans are significantly less positive on the Fed than Democrats (see below), although conservatives typically show less love for federal agencies in general, and that tendency has been more pronounced in recent years. As such, it has been something of a surprise to see the relative warmth with which Powell has been received by members of Congress. That sentiment has, no doubt, been aided by the strength of the US economy despite 15 months of rate hikes.
Dems fear job losses, GOP frets bank regulation
Despite facing little outright hostility during the proceedings, questions did sometimes veer into each side’s political agenda. In her opening statement to Wednesday’s House hearing, Congresswoman Maxine Waters (D-California) applauded the Fed’s decision to pause at its June meeting, gave the Biden administration credit for presiding over record job creation, and mentioned that inflation had been cut in half over the ten months since passage of her party’s Inflation Reduction Act. Heading into an election year where all eyes will be on the US economy, it was no surprise that Congresswoman Waters reiterated her caution “against any approach to monetary policy that ignores the Fed’s maximum employment mandate”—and, in fact, concern that the job market might substantially weaken was the main line of Democrats’ questioning during Powell’s two-day testimony. Powell emphasized that remarkable labor market strength still gives the economy plenty of cushion. For Republicans, banking regulation seemed to be the focal point, with lawmakers questioning Powell about the Fed’s plans to draft new rules following a wave of regional bank failures earlier this year. Powell clarified that regulation around things like tougher capital requirements are more likely to apply to the biggest US banks, shielding smaller institutions that were at the center of this year’s banking crisis.
The world’s central banks are diverging
In recent weeks, we’ve seen central banks playing a range of strategies in their attempts to address post-pandemic imbalances—persistent inflation chief among them—underscoring the difficulty for investors predicting the fate of the global economy with so many moving parts. While the last edition of Perspectives focused on the Fed’s hawkish pause in rate increases, a survey of action in other major economies (see below) highlights the striking divergence in policymakers’ approaches. Not everyone was happy taking a wait-and-see-approach. The European Central Bank (ECB) hiked its main rate by 25 bps to 3.5%, in line with expectations, though the bank’s forecast for inflation came in gloomier than traders expected, suggesting tightening was far from over. On the same day, the Bank of England and Norway’s central bank each jolted investors with surprise 50 bps hikes. Switzerland’s central bank also put in an expected 25 bps hike on Thursday, signaling there would be more to come. Earlier this month, the Bank of Canada showed us that a ‘pause’ isn’t always the end of tightening, raising rates after holding since January.
Meanwhile, as the chart above reflects, Asian economies have taken a markedly different path. In Japan, where deflation has reigned for decades, central bankers have maintained ultra-loose monetary policy despite rising prices in a bid to extend the surprisingly robust rebound in its economy’s growth. China faces an altogether different problem, with lower-than-expected inflation confirming weakness in its post-COVID economic recovery: a function of soft domestic demand, but also the poor outlook for exports in the face of Western economies’ tightening described above. In light of that, the People’s Bank of China has actually been cutting rates, and we expect more such stimulus in H2.
Pandemic-era inflation poses special challenges
One of the takeaways from over a year of policy tightening in most countries surveyed above is that the situation is anything but straightforward and policymakers don’t have a definitive playbook. As we’ve mentioned before, economists still don’t have an airtight model for how monetary policy impacts inflation. How long, for example, might the lag be between action and impact? And which measure of inflation, for that matter, is the right one? Of course, those questions apply to every monetary policy cycle. But in the wake of COVID-19, central bankers confront a range of completely new distortions, including pandemic savings that have clearly bolstered spending, as well as a disproportionate comeback in spending on services, both of which could dampen the effectiveness of higher borrowing costs in slowing demand. On the other hand, as savings diminish and if unusually high corporate profitability declines significantly enough—especially as rates near multi-decade highs—we could see a dramatic weakening of the economy, making the risk of an ‘overshoot’ by central banks that much more daunting. In the face of so much uncertainty, we believe the Fed and other central banks have been pretty clear that (a) inflation today is unacceptably high, (b) they want it to come back down to its long-standing target level, and (c) the perils of inflation expectations becoming ingrained still outweigh the risk of going one or two hikes too far. As such, we remain bearish and expect tightening to continue across Western economies.
Homebuilders making a comeback
May witnessed US housing starts surge to their highest level in over a year, reaching 1.6 million, a 21.7% increase from April. Single-family housing starts approached 1 million, up 18.5% from April. Moreover, in what’s considered a better leading indicator, housing permits issued in May increased by 5.2%, totaling almost 1.5 million. Meanwhile, existing home sales remained tepid, suggesting the limited inventory of existing homes has shifted a massive amount of demand to the much smaller market for new builds. That trend has been helped along by homebuilders adding incentives to sweeten the deal for buyers. Amidst such changes, the increase in sentiment within the sector has been palpable with the National Association of Home Builders reporting last Monday that builder confidence had become positive again for the first time in eleven months. That bounce in sentiment is only tempered somewhat by higher rates making things a bit tougher for builders on the financing side.
Home prices remain resilient
Such developments paint an interesting picture of the unexpected impact high rates have made on the US housing market: Rather than crashing the sector, as some expected, a rapid increase in interest rates has merely frozen it. Higher mortgage rates have discouraged homeowners from moving, which would entail giving up mortgages on their current property locked in at exceedingly low rates. Despite a recent upswing in new construction, inventory remains tight and median house prices have soared, up more than 30% (see below), far outpacing income growth and leading to historically poor affordability.
Is there any relief on the horizon for homebuyers? Perhaps. In its most recent report last Thursday, the National Association of Realtors (NAR) saw median home prices fall by 3.1% year-over-year in May, the biggest one-year decline since December 2011. Despite rising by 0.2% month-over-month, the NAR reported May home sales were still 20% lower than a year prior. While these stats might be a small consolation to anyone looking for an existing home today, our guess is that transactions are unlikely to fall much further unless we experience a severe recession, while ultra-low inventory levels should continue to limit the downside in home prices, even with the recent boost in construction mentioned above.