Jobs, Inflation, and the Fed
As we enter the homestretch for 2022, consumers, investors and Federal Reserve officials are saying “Good Riddance!” With 40 business days to go before we can close the chapter on the year, the themes remain the same: a resilient job market, stubbornly high inflation, and rising interest rates.
In October, the economy added 261,000 jobs and the unemployment rate drifted up to 3.7 percent (the rate has been remarkably stable, remaining between 3.5 and 3.7 percent since March). As we enter the fourth quarter of the year, job growth is decelerating. Over the past three months through October, monthly job creation has totaled nearly 290,000, down from the monthly average of 407,000 for the whole year, and a significant slowdown from the 2021 pace of 562,000.
While job creation and the headline unemployment rate get a lot of attention, the most important aspect of the jobs report for the Federal Reserve is wages, which were up 4.7 percent from a year ago. October was the first month where annual wage growth was below 5 percent since December 2021. Yes, I know workers want higher wages, but the central bank wants to see wages come down in order to help alleviate the four-decade in inflation.
It seems like a long time ago that the Fed started its interest rate hikes, but it was just this past March when the central bank was worried about the Russian invasion of Ukraine and chose a modest 0.25 percent increase in the fed funds rate. That action seems quaint, considering that the same officials have recently enacted four consecutive 0.75 percentage point increases, bringing the benchmark rate to a range of 3.75 to 4 percent, up from zero earlier this year.
Despite the Fed’s best efforts, prices are up by more than 8 percent from a year ago. The problem is one that the central bank acknowledged in the accompanying statement for the November meeting: there is a lag between the action of raising interest rates and how quickly those higher rates impact the economy. This new addition to the official statement suggests that the central bank could pull back on the size of future rate hikes, though Chair Jerome Powell has noted repeatedly that the Fed still “has a ways to go” before reaching the “terminal rate,” which is the rate at the end of the hiking cycle.
Can the Fed get to that magical terminal rate without throwing the economy into a recession? That’s the question plaguing investors right now. The economy contracted in the first half of the year, but came back in the third quarter, which more than erased the decline. That said, most economists don’t expect it to last and are penciling in a mild recession in the first half of next year. The reason is with every rate hike, there is a higher probability that the Fed’s campaign will slow down the economy too much, tipping us into recession.
Meanwhile, the Fed’s rate hike campaign, which directly influences short term lending, has also pushed up longer term rates, like the ones associated with most mortgages. A year ago, a 30-year fixed rate mortgage was just over 3 percent (near the all-time low); today, it has more than doubled to over 7 percent, a 20-year high. Consider this: at the end of last year, the homebuyer who put down 20 percent for a $400,000 house and snagged a 3.2 percent, 30-year fixed rate mortgage had a monthly principal and interest payment of $1,383; today, that amount would jump to $2,128, amounting to almost $9,000 every year.
Higher rates and prices have put the recent real estate acceleration into neutral. According to Redfin, “Housing-market activity is plunging further this fall than it did over the summer as mortgage rates near 7 percent, price drops have reached a record high, and home sales and new listings are dropping.” The National Association of Realtors (NAR) reported Existing Home Sales slid in September and are down 23.8 percent from a year ago.
The situation is impacting both buyers and sellers, with the former forced to remain on the sidelines amid a competitive rental market, and the later, who are unwilling to list their homes and give up their low mortgage rates, contributing to a decline in new listings (down 17 percent from a year ago). While home prices are not dropping precipitously, they are decelerating. In September, the median existing-home price was $384,800, an 8.4 percent increase from a year ago ($355,100), but down from the record high of $413,800 in June.
Sam Hall of Capital Economics expects that prices overall will fall by 8 percent from the June peak over the next year. Already there is evidence that the real estate frenzy is abating: fewer homes are selling above their list price; seller price drops are increasing, and the time of a home staying on the market is rising to a median of 50 days, up from the record low of 17 days set this past spring. The Fed is hoping that the housing market cools less dramatically than it did in 2006, when the real estate bust was the catalyst of the Great Recession.