RATE HIKES & RECESSION

The market is currently pricing in the potential of 3 more rate hikes by December. Just four weeks ago, the market was priced with the expectation that rate cuts would start in 2023. Case-Shiller reported US home prices fell 0.2% since last year. This would mark the first year over year decline since 2012. Inflation reports show improvement. Yet, we have more rate hates coming. 

The truth is, the market is unpredictable and change is inevitable. The key to success in this market is adaptability. Anticipate change, volatility and uncertainty.

Chairman Jerome Powell of the Federal Reserve has made it clear that the Fed intends to continue its inflation-curbing strategy. The strategy has been simple, hike rates and shrink the money supply. 

In his semiannual report to Congress, Fed Chairman Jerome Powell said that the central bank is "narrowly focused" on reining in inflation and that it will continue to raise rates until it is confident that inflation is coming down. Powell acknowledged that raising rates could slow economic growth, but he said that the long-term benefits of bringing down inflation outweigh the short-term costs. “There’s no painless way to 2% inflation.” 

With news of rate hikes circulating, demand could change. Seasonally adjusted mortgage applications for purchases increased by 1.5% compared to last week but remain 32% lower than this time last year. Mortgage applications are a good indicator of demand. 

Recession signals?

The Conference Board released their Leading Economic Index (LEI),  a composite of economic indexes that can signal peaks and troughs in the business cycle.

May brought a 0.7% decline, marking the fourteenth consecutive month of contraction. This points to “weaker economic activity ahead,” said Justyna Zabinska-La Monica, Senior Manager, Business Cycle Indicators. The last time this index fell for fourteen straight months was in 2007, before the great recession.

There are also signs of stalling economic conditions overseas, as the Global Purchasing Managers’ Index (PMI) showed that Japan is clearly in contraction while Australia, the Eurozone, and the United Kingdom all slowed and are just above contraction territory. The globe is interconnected, and economies of different countries rely on each other for trade. As a result, recessions tend to be globally synchronized because loss of demand in one country tends to pull activity in other areas down.

While usually there’s an average of 50% of global economies in a recession at the same time, certain circumstances like the COVID pandemic can lead to a larger level of synchronicity. This ongoing situation remains important to monitor in the months ahead.

Mild or not, without a recession, is a 2% inflation rate possible? I don’t think so. 

$32T IN NATIONAL DEBT 

On June 2, the debt ceiling was suspended through 2025. Since then, the US increased their debt by $701B. We’ve officially above $32T in national debt. 

What could go wrong?

In 1980, US National Debt as a percentage of GDP was 31%. In 2010, it was 87%. Today, its 121%. When the government spends more money on their debt payments than on programs to benefit citizens, we will have a serious issue. There are no signs that government spending will slow down.

• In 2023 alone, we will spend more on interest costs than Medicaid and Income Security Programs such as Social Security.

• Increased debt means we have less money to invest in the future. Education, Technology, etc. 

• Fewer economic opportunities for Americans: rising debt leads to less business investments and slows down economic growth. 

• Rising national debt in combination with high inflation would mean higher interest rates for a longer period of time.

“As long as inflation remains below a tolerable level, there is little reason to be concerned about a growing national debt.”

— David Andolfatto is a Vice President in the Research Department at the Federal Reserve Bank of St. Louis

When you have debt, you need income. Imagine your outgoing debt payments are 121% of your net income. You’d be at risk of default unless you could tap into your savings or liquidate from other investments to mitigate the risk. Solutions would include reducing the debt or increasing income. The government has the same problem. Now we know the US wont “default” and national debt could triple over the next decade, so how will they increase income/revenue? 

Income taxes drive a ton of revenue for the government. Should wages rise instead of tax rates? That might be the trillion dollar question. As the Fed continues to tighten up, wage growth seems unlikely. The job market could suffer, and the unemployment rate could double and we could still be too far from the 2% target inflation rate. Keep in mind, rising wages adds to the inflation problem and higher taxes rates could cripple buying power. Not an easy problem to solve, but one worth thinking about as you plan ahead.

HOMEOWNERSHIP MATTERS

Even though the report showed homeowner wealth increased across the board, there were significant differences among homeowners of different income levels:

• Low-income households, defined as those that earn less than 80% of the area median income, gained $98,900 in net worth from home appreciation alone over the past 10 years.

• Middle-income households — those that earned more than 80% and less than 200% of the area median income — gained $122,100 in wealth over the same period.

• High-income households — earning more than 200% of the area median income — gained $150,800.

The report also points out a big disparity among different ethnicities when it comes to the homeownership rate:

• The Black homeownership rate was 44.9% by the end of 2022.

• The White homeownership rate was 74.5%.

• The Asian American homeownership rate was 61.9%.

• The Hispanic-American homeownership rate was 48.5

Over the last decade, homeowners gained an average of more than $100,000 in home value across all racial groups considered in the study. 

Here's the breakdown:

1. Asian - $239,430 in gained value

2. Hispanic - $162,450 in gained value

3. White - $138,430 in gained value

4. Black - $115,430 in gained value

The ability to build wealth is not only an important part of providing financial stability but also for the economy as a whole. Home equity and retirement accounts make up 60% of a household’s net worth, according to the U.S. Census Bureau and the NAR report.

SOURCE: MONEY.COM 

Article Written and Provided by Padi Goodspeed, SVP at CCM