Persistent high rates and inflation, are we transitioning into a recession?
The Covid-19 pandemic has taken a toll on global economic health as major economies around the world place hard restrictions on the movement of people and goods. With the U.S. seasonally adjusted real gross domestic product (GDP) declining 9.56 per cent from fourth quarter of 2019 through the second quarter of 2020, all facets of the economy have been affected with substantial changes in labor supply, trades, tourism, and production (U.S. Bureau of Economic Analysis). Despite being the worse recession ever recorded, U.S. Fed’s ultra-loose monetary policy and fiscal stimulus have brought back the real GDP to pre-pandemic levels in the first quarter of 2021. By the fourth quarter of 2022, U.S. Real GDP is up 4.11 per cent from 2019 pre-pandemic levels.
Catalyzed by a low-interest rate environment and economic recovery, U.S. Real GDP has been growing at a stunning rate, will this be another sub-prime mortgage crisis driven by high inflation? In this article, we will explore how the pandemic-driven loose monetary policy can affect high interest rates, mortgage loans and Singapore’s property market.
The recent pandemic has caused central banks worldwide to keep borrowing costs to low-levels to stimulate the economy and to search for a viable Covid-19 vaccine. The excessive borrowings have driven markets to hit unprecedentedly elevated levels as the global supply crunch intensifies. With the now higher demand for goods and services, the shortfall in supply pushes higher inflationary levels in the economy.
The U.S. Federal Reserve has been declaring interest rate hikes to curb the elevated inflation but despite several interventions, the core consumer price index (CPI), which measures the change in goods and services less food and energy, shows insignificant change in inflation levels which shows entrenched inflation in the economy. With inflation levels running loose, this opens the possibility of the Fed furthering rate hikes to successfully bring inflation back to expected levels.
Figure 1: Consumer Price Index
Source: Federal Reserve Bank of St. Louis
Another round of rate raises
The September 2022 core CPI recorded a 6.66 percent increase in price levels, approximately up 6-fold from the May 2020 core CPI of 1.25 percent. A strong inflation data urged Fed officials to implement another 75-basis point increase in federal funds rate in the recent November meeting, marking a fifth straight increase of this size for this year.
If inflation becomes embedded in the economy, the Fed may be forced to undertake a sharp short-term recession by shocking the economy with interest rates much higher than we expect (Caldwell, 2022). The Fed stressed that the monthly reports must show consecutive strong positive signs of inflation easing before considering stepping brakes on the rate raises. With interest rates running at 3.25-4 percent, it will take time for the interest rate hikes to filter through the real economy and meanwhile investors are shying away from blue-chip stocks with the tech heavy NASDAQ100 down at 3.78 percent upon the interest rate decision.
The core CPI report in November beat expectations with a 6.3 percent rise, down from 6.6 percent previously. The release sparked a rally on Wall Street as investors bet on the Fed lifting a slightly lower 50 basis points on the upcoming December meeting. Markets now expect the Fed’s benchmark to peak at approximately 4.8 percent in May 2023, having previously predicted a peak of 4.6 percent estimated by most Fed officials in September.
What does this mean for the property market?
In the 10-year chart shown in Figure 2, mortgage rates have been range-bound as rates fluctuate between 2-5 percent. The pandemic triggered a low-interest environment and excessive lending that led mortgage rates to hit a low just slightly above 2 percent. As Covid-19 situation starts to ease in the economy, rapid growth in prices shown in Figure 1 suggest unsustainability and rate hike measures are implemented to cool the economy. For the property market, a strong correlation between the interest rates and mortgage loans resulted in the 30-year fixed rate mortgage loan peaking at 7.08 per cent in October 2022, the highest seen so far since March 2002.
Figure 2: U.S. 15 & 30-Year Fixed Rate Mortgage Average
Source: Federal Reserve Bank of St. Louis
Coupled with the future rise in interest rates, there is a high probability that the fixed rate mortgages will prolong this uptrend as we see the Fed taking a stronger stance on aggressive monetary tightening. In August 2020, the housing market saw 1,036m in new home sales while the report in July 2022 home sales were 532k, a 48.64 percent drop in transactions. The decline in housing sales and building permits can be seen across the state as the degree of reluctancy in buying homes increases progressively in the consumer demand-driven market. Despite seeing favorable signs of the slowing jobs market and the easing of the fixed mortgage loans, the Fed displays an unwavering stance in increasing rate hikes to bring inflationary levels back to the 2% expected levels.
Despite the drop in housing sales and high mortgage loans, new home prices have continued to surge to a median high of $438,100 in Q2 2022, a 15.1 per cent increase in housing prices from Q2 2021 (National Association of Realtors). However, median prices for both existing and new home prices are increasing but at a diminishing rate. The percentage changes for exisiting and new home prices are decreasing gradually implying that the jumbo rates are slowing affecting the real economy.
US labour market
Figure 2: All employees, Total Nonfarm
Source: Federal Reserve Bank of St. Louis
The US economy added 261,000 jobs last month showing a robust labour market defying Fed’s aggressive effort in slowing down employment. Despite an increase in employment, the unemployment rate rose a further 0.2 percent bringing it to 3.7 percent, slightly above the pre-pandemic low. Powell describes the current labour market as being “overheated” and warned that economic softening will not be occurring any time soon.
This is due to the lags in monetary policy that are yet to take effect in the real economy and may take a longer period than what was previously expected by investors. The closely monitored labour market has been the Fed’s greatest concern when adjusting rates as the Fed juggles between interest rates and full employment without restraining the economy too much.
On 25th Oct 2022, U.S. Senate Banking Committee Chair Sherrod Brown warns Federal Reserve Chair Jerome Powell of hurting the economy by increase in unemployment levels through excessive monetary tightening. Brown expressed that it is the Fed’s responsibility to tame inflation and not neglect in keeping full employment levels in the economy. However, in his letter Brown did not stress that the Fed should slow or stop rate hikes, but he did advise caution in rate hikes (Saphir & Ellis, 2022).
“The inevitable never happens. It is the unexpected always.”
As the US transition to the next phase of policymaking, Mary Daly, president of the San Francisco branch highlights the Fed’s concerns in reducing rate hikes. Daly said the Fed is facing a series of constraints and is contemplating between easing or restricting the economy. Considering the lag in monetary policy and significant rate hikes, Powell said the Fed could start discussing about reducing the pace of tightening as soon as the next meeting in December. However, Powell also reinstated that a slower pace does not stand for easier policy.
With a clear sign from Powell that the Fed is not supporting the idea of an easing policy, several economists and business leaders expect the US economy to experience a severe recession any time soon. Employee layoffs from corporate entities are happening across the sector as businesses struggle to stay afloat amid the crisis.
Former Boston Federal Reserve President Eric Rosengren predicts the recession to happen as early as next year. Driven by the strong U.S labour market, the wage growth rose 5.2 percent annually in October, above the Fed’s 3.5 percent target. Rosengren also said that the wage growth must decline for inflation to be align with Fed’s expectations (Gilchrist, 2022).
FRED. (n.d.). Real Gross Domestic Product (GDPC1) | FRED | St. Louis Fed. FRED. Retrieved October 27, 2022, from https://fred.stlouisfed.org/series/GDPC1
U.S. Bureau of Labor Statistics, Unemployment Rate [UNRATE], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UNRATE, November 15, 2022.
Hammond, G., & Bernard, S. (2022, October 7). Soaring mortgage rates to pile pressure on property markets worldwide. Financial Times. Retrieved October 27, 2022, from https://www.ft.com/content/528500c8-7cfa-4aaf-9fca-7692aafeb9ce
Zillow. (n.d.). Compare Today's Current Mortgage Rates. Zillow. Retrieved October 27, 2022, from https://www.zillow.com/mortgage-rates/
Financial Times. (2022, October 19). Live news updates from October 19: Suella Braverman departs, Putin declares martial law in occupied regions. Financial Times. Retrieved October 27, 2022, from https://www.ft.com/content/e5e3f15a-8099-45cc-a5d6-a7fa685917c3#post-64ec22b9-a3c3-42c0-9231-c764850caf76
Caldwell, P. (2022, October 21). Why We Expect the Fed to Cut Interest Rates in 2023. Morningstar. Retrieved October 27, 2022, from https://www.morningstar.com/articles/1106505/why-we-expect-the-fed-to-cut-interest-rates-in-2023
Pickert, R. (2022, Oct 13). Core U.S. inflation rises to 40-year high, securing big Fed hike. BNN Bloomberg. Retrieved October 27, 2022, from https://www.bnnbloomberg.ca/core-u-s-inflation-rises-to-40-year-high-securing-big-fed-hike-1.1831979
Saphir, A., & Ellis, A. (2022, October 26). Fed's Powell, on eve of next rate hike, urged to protect jobs. Reuters. Retrieved October 27, 2022, from https://www.reuters.com/markets/us/feds-powell-eve-next-rate-hike-urged-protect-jobs-2022-10-25/
Gilchrist, K. (2022, November 8). U.S. likely headed for mild recession in 2023: Eric Rosengren. CNBC. https://www.cnbc.com/2022/11/08/us-likely-headed-for-mild-recession-in-2023-eric-rosengren.html