Defeating the Inflation Monster, Inventory Shortages & a Possible Recession

Inflation is the supervillain of Mortgage Bonds, eroding their fixed rate of return. But there’s hope as inflation dropped in May, and June’s data might lower it further but the Fed delivered some bad news today about another possible rate hike in July. The housing market continues to face inventory shortages, dampening housing demand despite high buyer interest. The rise in signed contracts for new homes indicates a need for more supply. Home prices remain supported due to high demand and low supply. Median sales prices can be misleading, as they don’t necessarily reflect appreciation. Jobless claims saw a drop, but the 4-week average rose to its highest level since November 2021.

Mortgage Rates Move Up Modestly

Primary Mortgage Market Survey® U.S. weekly averages as of June 29, 2023

Mortgage rates have hovered in the six to seven percent range for over six months and, despite affordability headwinds, homebuyers have adjusted and driven new home sales to its highest level in more than a year. New home sales have rebounded more robustly than the resale market due to a marginally greater supply of new construction. The improved demand has led to a firming of prices, which have now increased for several months in a row.

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Week of June 26, 2023 in Review

Annual consumer inflation declined in May per the Fed’s favored measure. Plus, the tight supply of existing homes remains a key dynamic in the housing sector, impacting signed contracts and home prices. Read on for details:

  • Inflation Making Slow Progress Lower
  • Tight Inventory Preventing “Housing Demand from Being Fully Realized”
  • New Home Sales Soar in May
  • Spring Brings More Monthly Home Price Gains
  • Surprising Drop in Unemployment Claims

Inflation Making Slow Progress Lower

The Fed’s favorite measure of inflation, Personal Consumption Expenditures (PCE), showed that headline inflation increased 0.1% in May. The year-over-year reading fell from 4.3% to 3.8%, which is a significant improvement at nearly half the 7% peak reached last year.

Core PCE, which strips out volatile food and energy prices, rose by 0.3%. While the annual reading ticked lower from 4.7% to 4.6%, core inflation has seen a slower decline from its 5.4% peak.

What’s the bottom line? Inflation is the arch enemy of fixed investments like Mortgage Bonds because it erodes the buying power of a Bond’s fixed rate of return. If inflation is rising, investors demand a rate of return to combat the faster pace of erosion due to inflation, causing interest rates to rise like we saw throughout much of last year.

While inflation moved lower in May, June’s data could bring even more progress. PCE is a rolling twelve-month report, meaning that if we add the previous 12 monthly readings and account for rounding and compounding, we come up with the year-over-year figure. When the data for this June is released on July 28, it will replace the headline inflation reading for June 2022, which was elevated at 1%. If we see another 0.1% reading for this June like we just did for May, year-over-year inflation would drop to around 2.8%.  

Tight Inventory Preventing “Housing Demand from Being Fully Realized”

 pending home sales (3)

Pending Home Sales fell 2.7% from April to May, which was a larger decline than economists had forecasted. The West, Midwest and South all saw a drop in contract signings on a monthly basis, with only the Northeast posting gains in May. Overall, sales were down 22.2% when compared to May of last year.

Pending Home Sales are a crucial measure for taking the pulse of the housing market. The data is considered a forward-looking indicator of home sales because it measures signed contracts on existing homes, which represent around 90% of the market.

What’s the bottom line? Lawrence Yun, chief economist for the National Association of REALTORS�, explained, “The lack of housing inventory continues to prevent housing demand from being fully realized.” And there is demand among buyers, as he noted that we’re seeing “approximately three offers for each listing.” Quite simply, if there were more homes listed for sale, we’d have a much higher rate of signed contracts.

New Home Sales Soar in May

 New Homes Sales v2

New Home Sales, which measure signed contracts on new homes, rose 12.2% from April to May to a 763,000-unit annualized pace. Sales were 20% higher than a year ago, and at their best level since February 2022. 

What’s the bottom line? The rise in signed contracts for new homes correlates with the low level of existing homes that are listed for sale. This has helped boost confidence among homebuilders, which is a positive sign as more new homes are needed to meet the overall demand among buyers. While there were 428,000 new homes for sale at the end of May, only 69,000 (or 16%) were completed, with the rest either not started or under construction, meaning that available supply was below normal levels.

This ongoing dynamic of high demand relative to low supply will continue to be supportive of home prices.

On that note, the median sales price was $416,300, which was down from $450,700 a year ago. However, this figure is not the same as appreciation but represents the mid-price and can be skewed by the mix of sales among lower-priced and higher-priced homes. Recent appreciation reports from Case-Shiller and the Federal Housing Finance Agency have shown that home prices are rising again on a monthly basis, as detailed below.

Spring Brings More Monthly Home Price Gains

 case shiller hpi (1)

The Case-Shiller Home Price Index, which is considered the “gold standard” for appreciation, showed home prices nationwide rose 0.5% from March to April after seasonal adjustment, marking the third consecutive month of gains. Prices were 0.2% lower when compared to April 2022, though this is partly because home prices rose much more sharply in the first half of 2022 than they have so far this year.

The Federal Housing Finance Agency (FHFA) also released their House Price Index, which revealed that home prices rose for the fourth straight month, up 0.7% from March to April. Prices also rose 3.1% from April 2022 to April 2023.

Note that FHFA’s report measures home price appreciation on single-family homes with conforming loan amounts, which means it most likely represents lower-priced homes. FHFA also does not include cash buyers or jumbo loans, and these factors account for some of the differences in the two reports.

What’s the bottom line? The uptick in appreciation over the last few months suggests we’re past the inflection point and home prices are on the rise again. “The U.S. housing market continued to strengthen in April 2023,” confirmed S&P DJI Managing Director Craig J. Lazzara, who added that “the ongoing recovery in home prices is broadly based” with prices just 2.4% below their peak from June 2022. This is a far cry from the housing crash of 20% that some in the media have forecasted. 

Surprising Drop in Unemployment Claims

 jobless claims (9)

Despite declining in the latest week, Unemployment Claims remain elevated among both first-time and continuing filers. There were 239,000 Initial Jobless Claims reported, down 26,000 from the previous week. Continuing Claims came in at 1.742 million, which was a decline from 1.761 million the week beforehand.

What’s the bottom line? While Initial Jobless Claims saw a large drop after three straight weeks of remaining above 260,000, the measured week included the Juneteenth holiday, so the shortened filing time may have impacted the data. The 4-week average of Initial Claims, which smooths out some of the weekly fluctuation, actually rose to its highest level since November 2021 at 257,500.

Continuing Claims are also significantly above the low point of 1.289 million filers seen last September, though they have declined from highs reached earlier this spring, due in part to benefits expiring for some people. Overall, this data reflects the challenges many are facing as they search for new employment.

What to Look for This Week

After the market closures on Tuesday in honor of Independence Day, labor sector reports will dominate the headlines. On Thursday, look for the latest Jobless Claims data and ADP’s Employment Report for June, which will provide an update on private payrolls. Friday brings June’s Jobs Report from the Bureau of Labor Statistics, which includes Non-farm Payrolls and the Unemployment Rate.

Also, the minutes from the Fed’s June meeting will be released on Wednesday and these always have the potential to be market moving.

Technical Picture

Mortgage Bonds ended last week in a wide range between support at 99.125 and overhead resistance at 99.845. The 10-year tested an important overhead ceiling at 3.85%, which held last Thursday and Friday. If yields can remain beneath this level, there is a lot of room for them to move lower.

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