Personal income, spending, and prices: consumer remains strong, inflation close to 2% target no matter how you measure it

 

 - by New Deal democrat

I am on the road today, so I will have to keep this brief.

In June nominal personal income rose 0.3%, and spending rose 0.2%. Since PCE inflation rose less than 0.1%, real income rose 0.2% and real spending rose 0.1%.

Since spending on services tends to rise even during recessions, the more important component to focus on is real spending on goods. This rose 0.2% to its highest level ever except for last December:

As indicated above, PCE inflation was also subdued. The core measure rose 0.2%. On a YoY basis, PCE inflation is 2.5%, and core PCE inflation is 2.6%:

Both of these are at their lowest levels since the pandemic.

Finally, with the usual one month delay, real manufacturing and trade sales rose sharply, by 0.9%, also to their highest level ever except for last December:

The two big takeaways from this month’s report are that the consumer remains strong, and inflation, no matter how you measure it, is close to the Fed’s 2% target. Again, if that is indeed a target rather than a ceiling, the Fed has no reason not to proceed with at least several small interest rate cuts.

Coincident real GDP metric is good, but leading indicators from the GDP report are not: is the Fed listening?

 

 - by New Deal democrat

Real GDP grew 0.7% in Q2, or a 2.8% annualized rate, a perfectly good number in line with the past three years:

Probably even more importantly, the GDP deflator increased 0.6% for the quarter, or at an annualized rate of 2.3%. As the below graph shows, this is a perfectly normal rate going back to the start of the Millennium:

In other words, if 2% inflation is a target and not a ceiling, the Fed need not wait any further before starting to trim interest rates lower.

And the long leading indicators contained within the GDP report ought to give them more reason to cut, because both declined slightly.

First, private fixed residential investment as a share of GDP, a proxy for the housing market, declined slightly both in nominal (blue) and real (red) comparisons:

This doesn’t scream recession, but the generally flat trend of the past several years (with the supply chain tailwind now gone) at very least suggests lackluster growth ahead.

Secondly, real deflated proprietor’s income, a proxy for corporate profits (which won’t be reported for another month, also declined, by -0.4%:

Business profitability is also not providing any help to the economic outlook for 2025.

Continued resilient real consumer income and spending is keeping the economy growing. But the power sources for that engine are not providing any more juice. 

Again, not recessionary, but more evidence that the Fed should start to lower rates now.

Jobless claims hold their ground against the most challenging comparisons of last summer

 

 - by New Deal democrat

This week completed the most challenging YoY comparisons with last summer. Recall that I suspect there may be some unresolved post-pandemic seasonality in these numbers, as this year’s increase starting in late spring has been close to a mirror image of last year’s increase. So if there is some real new weakness in jobless claims, the last three weeks were the most likely times it would show up.

And the result this week was not too bad. Initial claims declined -10,000 to 235,000. The four week average increased 250 to 235,500. With the typical one week delay, continuing claims declined -9,000 to 1.851 million:

More importantly, on a YoY basis weekly claims were up a slight 1.7% (4,000), and the four week average was unchanged. Continuing claims were up 4.9%, still close to their recent YoY low comparisons:

This is a neutral result compared with the most challenging comparisons of last summer. Specifically, it does not suggest a recession in the near future.

Finally, looking ahead to next week’s unemployment rate for July, we see that the monthly numbers were about equal to June’s but higher than earlier this year:

This suggests some further upward pressure on the unemployment rate in coming months (recalling that the big wave of immigration in the last several years is almost certainly distorting that comparison upward). It’s possible the “Sahm rule” will be triggered as a result, but recall that the comparison rate for that rule is also going to increase 0.1% this month as well.

7%+ mortgages weigh on new home sales, while prices continue slight downtrend, and inventory uptrend

 - by New Deal democrat

Now that we have new as well as existing home sales, let’s take a little more extended look at the housing sector.

Let me start by reiterating the big picture: mortgage rates lead sales, which in turn lead prices. Further, new home sales are the most leading of all housing metrics, but they are noisy and heavily revised. The much less noisy single family permits lag them slightly. Finally, we are looking for relative normalization between the new and existing home sectors, which would mean *relatively* more existing vs. new home sales, firming in new home vs. existing home prices, and more inventory growth in existing homes vs. new homes. 

Only the third of these made progress in June.

Three months ago I wrote that “because mortgage rates have risen somewhat in the past few months (from 6.67% to 7.10%, I expect this range in new home sales to continue, with a slight downward bias in the immediate months ahead.” That is what has happened in the three months since. Mortgage rates (red in the graph below, right scale) remain elevated (over 7% on average in May) compared with earlier this year, so downward pressure has been placed on new home sales:

Specifically, in June new home sales declined another -4,000 to 617,000 annualized, with only a slight revision to May. This is on par with new home sales late last year when rates were also above 7%.

As expected, the much less noisy, but slightly less leading single family housing permits (red, right scale), have turned down with a slight delay as well:

Prices (brown) continued to rise after sales declined, and have since declined themselves slightly as well (if there were more combined new and existing home inventory, we would expect a steeper decline in prices):

On a YoY basis (red), in June the median price for a new home was almost exactly unchanged (down -0.1%):

But the slight downward trend over the past 12+ months remains intact.

Finally, inventory always lags sales, and this continued to climb to its highest all-time level except for the peak of the 2000s housing bubble:

For comparison, yesterday we saw that sales of existing homes remained near their 5 year lows, while inventory (not seasonally adjusted) rose to a three year high, and prices continued to rise YoY, but at a slower pace. Here is the graph of existing home inventories (not seasonally adjusted) for comparison:

Mortgage rates over 7% have thus continued to be an obstacle to normalization. Sales of both new and existing homes remain near five year lows. Prices of existing homes continue to rise faster than for new homes. Inventory for both new and existing homes is increasing, but the latter is increasing - from an extremely low post-pandemic level in 2022 - faster than the former, 23.3% vs. 11.2% YoY.

To sum up, there is still a long way to go on the journey to a normal housing market. I expect existing home inventory to continue to rise sharply until prices stop rising faster than prices for new homes. Meanwhile sales for both will continue their existing flat to slowly decreasing trend until mortgage rates are significantly lower.

Existing home market inventory and prices move slowly towards normalization, while sales remain punk

 

 - by New Deal democrat

Since existing home sales are less important for economic purposes, and especially with new home sales being reported tomorrow morning, I will keep this brief.

What we are looking for is rebalancing in the housing market. For that to happen, we want the inventory of existing homes to increase, prices to stabilize, and sales to gradually pick up.

In June we got two out of three.

The inventory of homes for sale increased to 1.32 M. This series is not seasonally adjusted, so we look YoY, and there we find that this is the highest inventory for June since 2020:

Meanwhile the YoY% gain in prices was 4.1%. This metric is also not seasonally adjusted, and there we got the lowest YoY% increase since last December:

But sales of existing home declined 0.22 M annualized in June to 3.89 M. This is at the bottom of its range in the past 12 months, and reflects the increase in mortgage rates several months ago:

So, inventory is increasing, and prices are increasing at a slower pace, but sales are not picking up at all, at least not with the mortgage rates of 7% we saw several months ago.

I’ll compare with the situation as to new houses tomorrow.

How restrictive are real interest rates?

 

 - by New Deal democrat

Over the weekend Harvard econ professor Jason Furman suggested that the Fed funds rate is not very restrictive:

“As inflation has come down the real Federal funds rate has risen and is now the most restrictive it has been this cycle, a point that Austin Goolsbee has emphasized a number of times. … That is not the way I would look at it. The rates that matter for the economy are long rates. and expected inflation over, say, the next decade has not changed that much. So the real mortgage rate, for example, is restrictive but not increasingly so.”

Let’s take a look.

First, here is the historical look at the real Fed funds rate, i.e., the nominal rate minus the YoY inflation rate. Since it is currently just under 2.4% higher than inflation, I subtract that so the current rate shows at the zero line below:

Indeed the current real Fed funds rate is the most restrictive since just before the Great Recession. Beyond that, it is also more restrictive than during most of the 1960s and 1970s. Only during the 1980s and the latter part of the 1990s was it consistently higher. We’ll circle back to this further below.

Also, note that interest rates -not so  coincidentally - were only as restrictive or more restrictive than their current levels shortly before recessions during the 1960s and 1970s, as well as the 2000s.

But what about compared with longer rates?  Here is the same graph, again normed to zero at its current readings for the real 10 year treasury rate (blue), real 5 year Treasury rate (gold), and real 2 year Treasury rate (red) since the turn of the Millennium:

The two year real rate is almost as restrictive as the real Fed funds rate over this nearly 25 year period. Further, while the 5 and 10 year real rates are *relatively* less restrictive, they are still more restrictive than at almost any time in the past 10 years, and about average for the 15 years before that.

Here is the same graph for the period of the 1960s through 1990s for which data is available:

Longer term real rates are less restrictive than at almost any point in the 1980s and 1990s, but about average for the 1960s and more restrictive than most of the 1970s.

So the conclusion is that longer term real rates are generally more restrictive than at most times in the past 25 years, and about average for the last 40 years of the 20th century.

Which isn’t that helpful.

For forecasting purposes, there are two more important points.

1. The ECRI method that uses nominal long term bond rates as one of their four indicators that goes into their ”long leading index” does not make use of the yield curve. Rather, it asks whether long rates are higher or lower than they have been previously in the expansion. We know that rates are higher than they were before 2023, but have been roughly flat since then.

2. Now let’s circle back to the 1980s and 1990s. What was important during both of those very long expansions is that rates, although high in both nominal and real terms, *trended lower.* For example, here are mortgage rates in the 1980s and 1990s:

One of my top-line forecasting systems is based on the fundamentals of consumer behavior. Consumers can get more money to spend via higher real wages. Or an asset, like stocks or real estate equity, can appreciate in value and be cashed in. Or the interest rates servicing those loans can go sufficiently lower to allow for refinancing, thus freeing up more cash for spending.

In the 1980s and 1990s, interest rates, especially mortgage rates, very frequently made new lows. Thus even those in real terms rates were restrictive, they were *less* restrictive generally than one or two years before. Consumers refinanced, and spent the freed-up cash. It was only when no new rates were established for 3 years, and other assets stopped appreciating, that recessions occurred.

Currently we have higher real rates than at almost any time in the past 10+ years, at a level of restrictiveness equivalent to before recessions in the 1960s, 1970s, and 2000s, and long term rates that have not made new lows in 3 years.

In other words, the refinancing spigot has been shut off. If stock prices, real estate prices, and real wages stop appreciating - which they very importantly have *not* at the moment - the economy is very vulnerable to a turndown.