The quandary of housing: almost all signs are classically recessionary; so why hasn’t there been a recession?

 

 - by New Deal democrat

As I reiterated the other day, housing is the one long leading signal of the economy that has been soundly negative - indeed frankly recessionary - for the past year. That trend continued in March, although there are signs of it bottoming out. Without having caused a recession. 

Let me start with mortgage rates (blue, left scale) compared with single family permits (red, right scale). Typically housing permits and starts follow mortgage rates, and for most of the past several years they had been declining from their post pandemic high of over 7%. In February they made a new 3+ year low of 5.99%. The decline was sufficient to reverse the trend in single family permits (red, right scale), which began to rise from their bottom early last summer:

Of course mortgage rates did rise in March, and this appears to have put a damper on permits (blue in the graph below) which declined -166,000 to 1.372 million annualized, the second lowest reading since 2020. On the other hand, the more noisy starts (gold) rose 146,000 to 1.502 million annualized, the highest in 15 months. But the metric that is the least noisy of all and conveys the most signal, single family permits (red, right scale), declined -35,000 to 895,000 annualized, nevertheless continuing its general uptrend since the beginning of last summer:

On a YOY% basis, starts are (noisily) up 10.8%, while permits are down -7.4% and single family permits are down -7.9%. Typically all three have been down 20% or more at the onset of recessions in the past, although in the 1991 and 2001 recessions, they were only down about -10%:

Note that the downtrend has not been worsening for many months. Further, there have been a number of times, for example 1966, 1987, and 1995, where construction has been down -10% or more YoY without a recession occurring.

Let’s turn next to the number of housing units under construction. As I have written many times in the past several years, it is the best “real” measure of the economic impact of housing (blue in the graphs below). In March they were unchanged at their five year low of 1.264million annualized. They are also down -26.3% from their peak:

The above graph shows how they have followed single family permits (red), as expected. More often than not in the past by the time a decline in units under construction had declined by this much, a recession had already begun. The only two exceptions were the late 1980s, where the pre-recession decline was -28.2%, and 2007, where the pre-recession decline was -25.6%. 

Now let’s compare housing units under construction with the typical final shoes to drop before recessions, houses for sale (gold) and residential construction employment (red), all normed to 100 as of their respective post-pandemic peaks. Uniquely, employment in residential construction has risen slightly since last August, even though the number of units under construction has continued to decline. Meanwhile housing units for sale have continued to decline:

Now here is the same data presented in YoY% change format:

In the past 40 years, houses for sale and employment in residential construction had turned down YoY before the recessions had begun. After making a trough at -1.4% YoY, residential building employment is now only down -0.4%; while housing units for sale are down -4.0%, the weakest YoY reading since summer 2023.

So we end with a quandary. With the sole exception of employment (which may be reflecting, and distorted by, the ICE raids on construction workers), all of the indicators in the housing sector are giving classic signs that a recession should be underway — and they have been since late last year.

And yet there are a number of signs that the situation has been bottoming, without a recession having occurred. As I wrote in my note earlier this morning about new capital goods orders, this may be because the Boom in AI data center construction and operation has more than overbalanced declines in things like real income, or real personal spending on goods, and the complete stall in employment growth since early last year. We should get more information about this tomorrow from the release of personal income and spending in March, as well as Q1 GDP.

Capital goods orders rise to a new all-time record high in March

 

 - by New Deal democrat

There was some important housing data this morning; but first I wanted to drop a brief note on the advance report on manufacturing that also was released, because it is yet more confirmation of the (surprising) strong positive trend in that sector.

This report covered March, so included the first few weeks of the Iran war. While overall manufacturers new orders rose 0.8% (blue), the real surprise was in core capital goods orders, which importantly excludes the defense sector (red), which rose a sharp 3.3% to a new all-time high:

Suffice it to say, the impact of tariffs has been completely absorbed by the system. There are two important factors to note: (1) much of this probably reflects the Boom in AI data center construction; and (2) I saw a note last week suggesting that the closure of the Strait of Hormuz was causing manufacturers’ to speed up new orders in order to try to have supplies on hand before the delivery pipeline shut down. Needless to say, both of these suggest that there is likely to be a rapid reversal, because in the first case exponential growth must eventually end; and in the second hoarding is just front-running.

But for now, a very positive short leading sign in the manufacturing sector.

Repeat home sales, new rents continue to show almost *no* inflationary pressure in shelter costs

 

 - by New Deal democrat

Three housing metrics have been reported between yesterday and today. Yesterday Apartment List updated their National Rent Report, and today the two national repeat home sales indexes, from the FHFA and Case-Shiller, were updated through February. To cut to the chase, all three confirm that housing prices have ceased being an engine of inflation.

The Case-Shiller National index (blue in the graphs below) increased 0.1% for the three month period ending in February, while the FHFA index (red) was unchanged:

Just as important if not moreso is that the YoY comparisons of at least one of the two national indexes continued to show further disinflation. While the FHFA Index increased 1.7% YoY, a 0.1% YoY increase from January’s 14 year low, the Case Shiller national index increased only 0.7% YoY, the lowest since the Great Recession’s housing bust except for April through June 2023:

As per usual, since housing prices lead the CPI’s shelter component by roughly 12-18 months, let’s compare the YoY trends (Note: house price indexes /2.5 for scale):

Last month I wrote that the repeat sales indexes provided “solid evidence that we can expect shelter inflation in the CPI to continue to decelerate throughout this year ….  with the shelter component ending this year at close to a 2.0% YoY increase.” Since then, the CPI report for March indicated a continued 3.0% increase; but there is every reason to expect continued disinflation.

That disinflation in shelter costs was reinforced by yesterday’s National Rent Report, which indicated that new apartment rents declined -1.7% YoY:

I should note that the BLS’s “New-“ and “All Tenants Rent Index” which were last updated in January for Q3 of last year, have been “temporarily suspended” due to last autumn’s government shutdown, which apparently affected their collection and measurement procedures. This is a shame because those indexes have been developing a good record for forecasting the trend in rents in the CPI.

But the bottom line is that all of the three reports indicate that the purchase price of an existing home, as well as rent, are providing no or at worst very limited upward pressure on shelter inflation.

Updating the long leading indicators: money and credit, plus overall review

 

 - by New Deal democrat

In the past week, I have been updating my suite of long leading indicators. First I looked at “real” consumer-focused indicators. Then I looked at housing, an important interface between consumers and producers, as well as corporate profits. Next I updated interest rate indicators. I this final installment I will look at money and credit indicators.

Let’s start with money, in the form of real M1 and M2. Money supply indicators were all the rage late in the last century, in the wake of Milton Friedman’s influence. Subsequently they have fallen out of favor, but they are still useful, as we will see below.

In the immediate wake of COVID, the Fed flooded the economy with money, quadrupling M1 and increasing M2 by about 15% during and immediately after the COVID lockdowns. In real terms money supply peaked in Q1 2022 (set to 100 in the graph below). Subsequently the Fed withdrew money from the economy, with real money supply making its post-pandemic low in April 2024:

Since then both real M1 and M2 have risen about 3%. This is a positive signal.

But the best way of looking at money supply for forecasting purposes is YoY. As the historical graph below shows, no recession has ever started with a positive YoY real M1, or a YoY real M2 growing by more than 2.5%:

Before the pandemic, when both of those conditions had been met simultaneously, with the exception of 1966 and briefly in 2005, a recession has always followed, usually about 1 year later.

Here is the post-pandemic close-up:

Both real M1 and M2 turned very negative in late 2022 through 2023, a false positive signal. Since then both have turned positive, with real M1 being up 2.3% YoY as of February, and real M2 up 2.4%. Both measures are also accelerating, something that is typically seen early in recoveries in the wake of recessions.

In short, real money supply is a substantial positive at present.

Now let’s turn to credit, as measured by the quarterly Senior Loan Officer Survey, which was most recently updated in February for Q4 o last year. There are two metrics in that survey which have been reported since 1990, and so have long enough historical records to be valuable: the percentage of banks tightening vs. loosening credit standards, and demand for credit.

First, here is the change in lending standards, with net tightening being the positive value:

The 1990s and 2000s expansions followed a classic pattern, with standards being loosened in the early phase and tightened in the later phase. The very long 2010s expansions appeared to be following a similar pattern, until it was nuked by COVID. In the past-pandemic period, standards initially became “less tight” but never have actually become “loose.” Rather, for the past two years they have remained slightly tight. This is a somewhat negative indicator, especially considering that there was a similar such “slightly tight” episode in 1999 and early 2000, before standards tightened sharply.

Demand for credit is broken down both by large banks (dark red and blue, thick lines) and smaller banks (light red and blue, thin lines), and also by whether the demand is from large firms or smaller firms. Here is the entire historical view:

All of the last three recessions have only occurred after all segments of demand for credit went into decline. Whether there would have been a recession in 2020 in the absence of the pandemic and its lockdowns is one of those things we will never know.

In any event, the only segment negative in the last report, and only slightly, is demand from smaller firms from smaller banks. On the other hand, demand by large firms from large banks is at one of the highest levels ever (I strongly suspect this is related to the construction of AI data centers).

In any event, the demand segment of the Senior Loan Officer Survey is nowhere near suggesting a recession is close.

This completes my updating of the long leading indicators. So let me sum up:

1. Real retail spending and real spending on goods per capita are neutral, very close to turning negative but not (yet) having done so.

2. Housing is recessionary - and has been for many months.

3. Corporate profits are very positive.

4. Interest rate levels, particularly for corporate bonds, are neutral.

5. The yield curve is positive, but with the imporant asterisk that the manner of its regularizing has been unique.

6. Real M1 is positive and real M2 on the cusp of giving a positive signal.

7. Credit standards are slightly tight, and so a slight negative.

8. Demand for credit is almost uniformly positive.

Note that only 1 metric - housing - is absolutely negative, with another - credit standards - only slightly so. Two producer side metrics - profits and demand for credit - are very positive. The rest are generally neutral or mixed, or in the case of the yield curve, positive but with a very important caveat.

Of the metrics that are only reported quarterly, corporate profits won’t be reported for Q1 until the end of May, although proprietors’ income will be updated later this week. The Fed has not yet indicated when the Senior Loan Officer Survey will next be updated, although it is likely to be sometime in May. 

Weekly Indicators for April 20 - 24 at Seeking Alpha

 

 - by New Deal democrat

My “Weekly Indicators” post is up at Seeking Alpha.

This past week had a particular paucity of monthly data, and incremental movements in the high frequency data. In particular, oil and gas prices retreated a little bit, and with a slight downturn in mortgage rates some people rushed out to lock in what looked to be - relatively speaking - the best rates they were likely to get.

As usual, clicking over an reading will bring you up to the virtual moment as to the state of the economy, and reward me with a little lunch money.

Updating the long leading indicators: interest rate levels and duration spreads

 

 - by New Deal democrat

As I noted earlier this week, I haven’t updated my suite of long leading indicators in awhile, mainly because they have been overwhelmed by the economic chaos emanating from Washington, and partly also because several important ones are in terra incognito. On Monday and Wednesday I updated the non-financial elements of the long leading indicators having to do with housing and consumer spending. Today let me focus on one of the financial elements, that has been most puzzling: interest rates.

The interest rate elements of the long leading indicators come in two varieties: the *level* of rates, and the *duration spread* of rates. If we start from the idea that interest rates are “the cost of renting money,” then the former simply means that renting money at a lower rate of interest is always better than renting it at a higher rate of interest. The latter means that normally we would expect to pay a higher rate of interest the more we risk dealing with unforeseen issues further out into the future. If the immediate future is deemed more risky, something is wrong.

The level of rates has typically been measured by corporate bond yields, and there are systems that rely on such rates going back 100 years. In fact we can take the relationship all the way back to the 1850s if we measure by short term corporate paper. So let me start by directing your attention to the red line in the two below graphs, which shows the interest rate on BAA rated corporate bonds, historically from the 1980s through the present:

While it is absolutely true to say that not every significant increase in corporate bond yields presaged a recession, it is true that all recessions (except for the brief pandemic lockdown) were presaged by an increase in those rates.

Now let me explain the blue line. It is a similar measure, but for Treasurys, using the average of 3 month, 2 year, 5 year, and 10 year notes, which captures short, medium, and longer term rates. Like corporate bonds, there were significant increases in the average Treasury interest rates before each recession - although note the sharp increases in 1994-95 did not presage a recession.

Now let’s focus on the last few years of the same data:

After the very sharp interest rates increases of 2022 into 2023 - which did not presage a recession (at least not in the ensuing 3 years!), both corporates and Treasurys have meandered within relatively narrow ranges — the former between 5.4% and 6.4%, and the latter between 3.6% and 4.6%. Corporate bonds are currently almost right in the middle of that range, while Treasury rates at the short end have contributed to a downtrend in those rates which has not really been broken by the increase that started with the onset of the Iran war.

In short, the *level* of bond rates is not sending a negative signal at this time, but rather “neutral.”

Now let’s turn to the duration spread or yield curve measure.

Here is the historical graph from the 1980s until the pandemic of the 10 year (blue), 2 year (gold), and 3 month (red) Treasurys, together with the Fed funds rate (purple):

In general, throughout most of these economic expansions, the longer the duration of the government note, the higher the interest rate it commanded. Further, not every significant increase in the Fed funds rate (1984, 1994) gave rise to an inversion. But in 1989, 2000, and 2006 there were across the board inversions, where in response to the Fed hiking rates, the shorter the duration of the note, the higher the interest rate was demanded. And sure enough, recessions followed. Further, those recessions ended about 4 to 8 months after rates were fully normalized.

Now let’s turn to the post-pandemic record:

We had a nearly full inversion of the curve in 2023-24, with only the 3 month note paying slightly more than the Fed funds rate. Both widespread models for recession forecasting, featuring the 10 year minus 2 year, and 10 year minus 3 month spreads signaled “recession ahead.” 

But the curve started normalizing in late 2024 (as to the 10 year minus 2 year spread), and then in 2025 (as to the 10 year minus 3 month spread). The normalization was completed earlier this year when both the 2 year and 3 month spread turned higher than the Fed funds rate. 

Based on past experience, that is a positive signal for roughly year end 2026 and beyond.

But there is one wrinkle, because as I pointed out about a month ago, this is the first time in history that a yield curve has normalized by Treasury note rates moving *higher*, rather than following a decline in the Fed funds rate *lower.* This is terra incognito.

There is one somewhat similar episode from the past which ought to indicate caution is still very much warranted. Here is the smae graph focusing in on the Great Recession:

Note that the yeild curve started to normalize in late 2007, and was almost completely normalized (with only the Fed funds vs. 3 month spread remaining inverted) by spring 2008. Further - and very similarly to right now - part of that normalization was the increase in interest rates in the 3 months and 2 year notes. And then the investment banks imploded.

Just like now, in spring 2008 there was a gas price spike, from roughly $3 to $4.25/gallon:

It was this inflationary pulse which caused interest rates to increase. That finally broke the proverbial camel’s back.

While the current gas price spike is not as severe either in terms of GDP or average wages as the one in 2008, there is nevertheless an inflationary pulse in the economy. So while the duration spread indicator is positive, the uniqueness of its regularization warrants a big fat asterisk.