The UK house market continued to falter last month, industry research showed on Thursday, as prices and sales both fell in response to higher mortgage costs.
According to the latest residential market survey from the Royal Institution of Chartered Surveyors, the net balance for house prices softened to -47 from -42 in December.
A balance measures the difference between the percentage of surveyors seeing rises and those reporting falls.
New buyer enquiries also fell, with a net balance of -47 compared to -40 a month previously, the ninth successive negative reading. The new instructions balance came in at -14.
RICS said the market was still adjusting to the higher borrowing costs, after mortgage rates rocketed in the autumn in response to the government’s disastrous mini-budget.
Surveyors did not forecast any short-term improvement. The near-term price expectations measure was -66, while sales were expected to continuing falling in the coming three months, with a balance of -49, although that was a marginal uptick on December’s -54.
Simon Rubinsohn, chief economist at RICS, said: “Although some respondents noted a little more interest in the housing market as the new year got underway, the overall tone of the feedback still remains subdued, which is not altogether surprising given the jump in mortgage rates since the autumn.
“Prices, meanwhile, are now beginning to reflect the shift in balance between demand and supply.
“However, it is questionable how much downside to pricing there is likely to be, given that recent macro-forecasts from the Bank of England and others are now envisaging a less harsh economic environment this year.”
“Indeed, we now see too much downside risk to our long-held forecast of a 15-20 per cent peak-to-trough fall in house prices and downgrade to a 20-25 per cent correction (negative 15 per cent in 2023).”
Sydney’s property prices dropped 1.2 per cent in January to $999,278 in January, the first time in nearly two years that homes are worth less than $1 million on average. Sydney’s prices have fallen 13.8 per cent over the past year, the fastest of any capital according to CoreLogic’s figures. Nationally prices are down 7.2 per cent over the past year.
10pc gain in 2024
If Jarden’s forecast plays out in full, national prices would return to 2020 levels, effectively wiping out most of the surge in prices through the COVID-19 period, its analysts noted.
However, a recovery may be around the corner with a 10 per cent or more gain in prices forecast through 2024, if rate cuts, an easing on borrowing rules and tax cuts combine to improve borrowers capacity.
The key to the recovery lies in the easing of the 3 per cent serviceability “buffer” that lenders must add to current mortgage interest rates when assessing a new loan. The serviceability buffer has been deployed as macroprudential measure by the Australian Prudential Regulation Authority.
Jarden said one likely move by APRA would be to lower the serviceability buffer from 3 per cent to 2 per cent, a decision that could take place by September this year.
“In isolation, this would increase borrowing capacity by around 10 per cent, materially reducing the downside risk,” the Jarden analysts wrote.
“If APRA does not ease policy as we expect, there is likely further downside risk for prices, at least until the RBA cuts rates. Importantly, this combination of regulatory easing, rate cuts and the commencement of the Stage 3 tax cuts (worth $20 billion annually) is likely to drive a strong rebound for housing in 2024.”
CoreLogic analysis this week shows there is still some way to go before dwelling values return to pre-COVID-19 levels, except in Melbourne where average prices are just 0.4 per cent away from their March 2020 level.
Sydney’s prices would need to drop 6.9 per cent to wipe out gains from the housing boom. Nationally, prices are still 13 per cent above their March 2020 level.
RISING interest rates and the escalating cost crisis has slowed home sales in the north, but new research from Ulster University has found it has yet to produce any meaningful fall in house prices.
The university found the average price of a home in Northern Ireland actually increased by 1.3 per cent in the fourth quarter of 2022 to £207,327.
The index uses different methodology from the officially recognised NI house price index, produced by Land & Property Services (LPS), which put the average house price at £176,131 for the third quarter of 2022.
Ulster University’s research found that despite attempts by the Bank of England to get a handle on inflation by increasing mortgage interest rates, the heightened affordability pressures for potential buyers has reduced market activity yet there has been no decline in overall house prices.
There was some evidence that recent events have had an impact on some sectors.
The average price of a terrace/townhouse fell 4.1 per cent between the third and fourth quarter to £134,440, according to the UU index.
The detached sector also showed a marginal decrease of 0.2 per cent to £292,773.
But the university’s research showed the average price of an apartment increased by 5.6 per cent to £158,300 between the third and fourth quarters of last year, while semi-detached homes increased by 1.7 per cent to £190,882 on average.
Lead researcher Dr Michael McCord, said: “There are signs of purchaser demand and sentiment weakening invariably due to consumers adopting a ‘holding position’ to see whether interest rate increases have peaked and what appears to be the beginning of an easing inflationary environment.
“The housing market, to a certain extent, continues to be protected from any severe price correction due to the ongoing imbalance between demand and supply and the chronic lack and quality of private rental stock.”
Ursula McAnulty, head of research at the Housing Executive, which commissioned the research, described 2022 as “tumultuous”.
“Pricing levels overall have shown remarkable resilience, particularly in the context of high inflation and rising interest rates,” she said.
“This resilience is, partially at least, the result of supply side issues within the housing market, although the sub-regional variation in house price growth, and the continued slowdown in buyer enquiries and activity, somewhat dampen this view.”
Meanwhile, a separate study published on Thursday showed downward trends in demand, sales and listing across the Northern Ireland housing market in January.
The monthly residential market survey from the Royal Institution of Chartered Surveyors (Rics) and Ulster Bank, showed a continued decline in property professionals reporting new buyer enquiries.
January was the seventh consecutive month the survey detected falling new buyer enquiries.
New instructions to sell also fell for the fifth consecutive month.
Samuel Dickey, spokesperson Rics in the north, said: “As expected, the lack of stock coming onto the market continues to be an issue. Some potential buyers are giving careful consideration to purchasing, which is unsurprising given the current market landscape, including interest rate movements. We are also seeing respondents reporting demand scaling back from highs last year.”
LONDON, Feb 9 (Reuters) – Britain’s housing market suffered the most widespread price falls since 2009 last month as the run of interest rate increases over the past year weighed on would-be buyers, according to a survey published on Thursday.
The Royal Institution of Chartered Surveyors (RICS) house price balance, which measures the gap between the percentage of surveyors seeing rises and falls in house prices, fell to -47, the lowest since April 2009, from -42 in December.
A measure of interest from buyers also fell to -47, its lowest since October last year.
Simon Rubinsohn, chief economist at RICS, said the overall mood of the market as measured by surveyors remained subdued.
“However, it is questionable how much downside to pricing there is likely to be given that recent macro forecasts from the Bank of England and others are now envisaging a less harsh economic environment this year,” Rubinsohn said.
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The BoE last week said Britain’s economy would probably fall into recession in early 2023 and would only come out of it in early 2024, a shorter period of contraction than in its previous set of forecasts.
The RICS report showed surveyors were less pessimistic about the outlook than in December with a measure of expected sales over the next 12 months improving to -20 from -42.
Other housing market measures have also recently shown a loss of momentum following the surge in demand seen during the coronavirus pandemic.
A Reuters poll of economists and analysts in November predicted house prices would fall around 5% this year having surged by 28% since the start of the pandemic in 2020.
RICS said the rental market continued to show strong interest from tenants with limited availability of stock.
Reporting by William Schomberg; editing by David Milliken
Our Standards: The Thomson Reuters Trust Principles.
The latest report from RICS makes for grim reading for landlords and homeowners with news that sales and house prices continued to decline across the residential market in January.
In addition, landlords continue to flee the sector for the tenth consecutive month, while tenant demand continues growing.
On top of that, house prices fell with every region seeing price falls – the East Midlands and South East being hardest hit.
The month also saw the number of buyers and sellers falling, along with agreed sales.
Build to Rent will play a bigger role in the PRS
The RICS survey also found that 64% of its members believe that Build to Rent will play a bigger role in the PRS – but not in the short term.
Simon Rubinsohn, RICS’ chief economist, said: “Meanwhile, the rental market continues to show strong interest from tenants and the limited stock available is keeping a firm momentum to rental growth.
“While Build to Rent clearly has a role to play in helping to fill this gap, the insights from the latest survey suggest that this is not going to be sufficient, at least in the near term, to address the challenge in this market.”
‘Landlords continued to sell up and leave the market’
Sarah Coles, the senior personal finance analyst at Hargreaves Lansdown, said: “Landlords continued to sell up and leave the market and some have decided to cash in while property prices are higher, others are getting out of the business because rising mortgage rates means they can no longer make the sums add up.
“They’re also being pushed out by punishing tax rules and tougher landlord legislation – both of which mean higher costs.”
Ms Coles highlights that tenant numbers are still rising but there are fewer rental properties, so rents are going up.
She added: “It means that if you’re moving properties, there may be little scope for negotiation because there are an average of six people competing for each home.”
She says that tenants could try to negotiate a lower rent rise because the landlord may be tempted to keep a reliable tenant in place.
Things are unlikely to change soon
The January 2023 UK Residential Survey from RICS points to a muted housing market and things are unlikely to change soon as the sector adjusts to higher interest rates.
Mr Rubinsohn said: “Although some respondents have noted a little more interest in the housing market as the new year got underway, the overall tone of the feedback still remains subdued which is not altogether surprising given the jump in mortgage rates since the autumn.
“Prices, meanwhile, are now beginning to reflect the shift in balance between demand and supply.
“However, it is questionable how much downside to pricing there is likely to be given that recent macro forecasts from the Bank of England and others are now envisaging a less harsh economic environment this year.”
‘January was deathly for the property market’
Ms Coles said: “January was deathly for the property market. Despite falling mortgage rates, buyers and sellers gave up the ghost, with buyer numbers continuing to fade for the ninth month in a row.
“Meanwhile, house prices declined for the fourth consecutive month – and the proportion of agents reporting house price falls rose again.”
She added that the RICS report offers a more accurate view than other indices because it measures the price of homes among sales being agreed that month.
That means there’s not the usual lag for three months or more while sales translate into property completions.
She continued: “The most recent RICS data indicates that we can expect a steady flow of bad news about house prices well into the spring.
“Estate agents aren’t convinced the picture will change in a hurry.
“They expect the market to stay quiet and for prices to keep declining, as buyers get to grips with higher mortgage rates and the prospect of a falling market.”
Last week, the Australian Bureau of Statistics (ABS) released mortgage data for December, which recorded a massive 4.3% decline in new mortgage commitments (excluding refinancings) over the month, with the value of loans crashing 29% over 2022.
This, of course, followed 300 basis points of monetary tightening from the Reserve Bank of Australia (RBA), which are the most aggressive interest rate hikes in Australia’s history.
The value of new mortgage commitments (excluding refinancings) is a strong leading indicator for home values, as illustrated clearly in the next chart:
New mortgage growth typically leads home value growth by between three and six months.
Thus, the crash in mortgage commitments signals ongoing house price falls at the national level for the foreseeable future.
The same forces are in play across Australia’s three biggest capital cities, which are leading the nation’s housing downturn.
Sydney mortgage growth crashed by 35% in the year to December, which pulled home values down 13.8% in the year to January 2023:
Melbourne mortgage growth collapsed by 30% in the year to December, which dragged home values down 9.3% in the year to January 2023:
Finally, Brisbane mortgage growth plummeted 28% in the year to December, which has pulled annual home values down 4.1% as at January 2023, with heavy declines inbound:
With the RBA’s 0.25% rate hike on Tuesday, and further increases likely in the months ahead, buyer demand will inevitably shrink in response to reduced borrowing capacity.
In turn, Australian home values will be pulled deeper underwater, with a recovery unlikely until the RBA changes track and begins cutting rates.
If you are looking to shave thousands of dollars off your mortgage, try the MacroBusiness Compare n Save mortgage comparison tool. It takes less than a minute.
After continuous house price hikes that came from high demand after the coronavirus pandemic, we are now hearing that property prices are finally falling across the UK.
Recent figures from Nationwide and Halifax have shown consistent falls in average house prices over the last five months which is great news for first-time buyers, but not-so-great for sellers.
However it appears that despite the property market cooling elsewhere, Greater Manchester isn’t showing any signs of slowing down. Using data from the HM Land Registry, we have looked at what the average price of a home was back in October 2022 compared to February 2023, and found that prices are continuing to soar.
Here we have listed the 10 parts of the region where house prices have shot up huge amounts in the last few months which indicates a high level of interest and demand in each area.
House prices in Bramhall, one of the region’s most desirable neighbourhoods, have risen the most out of all areas of Greater Manchester in the last few months.
The average cost of a home in the Stockport suburb is now £494,819, which has gone up by £48,558 from £446,261 in October 2022.
Broadheath, a town in Trafford, has seen house prices rise by a considerable amount in the last five months.
The average cost of a home in the area was £303,094 back in October, but this has now jumped up by £46,096 to £349,190 in February.
Bowdon has been proved to be Greater Manchester’s most expensive area to live for quite some time. House prices in the affluent Trafford suburb have always been well above average but it appears they are continuing to rise.
Back in October, the average price of a home in the area was £855,886, but in February, this has now jumped up to £41,872 to £897,758.
Heaton Chapel, Stockport
Heaton Chapel in the northern part of Stockport has also seen the price of properties rise in recent months.
The average cost of a home here is now £358,329, which has gone up by £32,495 from £325,835 back in October.
Cheadle Hulme, Stockport
Another area of Stockport, Cheadle Hulme, has seen house prices shot up since October.
Five months ago the average house price in the village was £333,750 but this has now climbed by £31,557 to £365,327 as of February.
Heaton Norris, Stockport
The Stockport suburb of Heaton Norris, which neighbours Heaton Chapel, now has an average house price of £300,921.
This has gone up by £28,005 since October when you could typically buy a home for around £272,916.
In the Bury borough, the town of Whitefield has also seen house prices go up in recent months.
Last October, the average house price was £249,169 but this has now climbed by £25,536 to £274,705.
Property prices are also on the rise in Radcliffe, having gone up by £25,435 in the last five months.
The average price of a home was £206,554 back in October, but it is now likely to cost you around £231,989.
In the market town Audenshaw, house prices have also risen by £25,428 since October.
The standard cost of a property is now £221,088 having gone up by £25,428 from £195,660.
Property prices have also risen in Ardwick, an area which sits just one mile south east of the city centre.
The average cost of a home here was £179,971 back in October, but in February the average house price has now gone up by £24,772 to £204,743.
Falling property prices and a drop in houses available for sale have not deterred sellers demanding top dollar for their houses.
Data based on all listings on the property website realestate.co.nz showed an 11 percent increase in sellers’ asking prices last year compared with 2021, or $12.5 billion.
Auckland was the only region where the sum of asking prices decreased 6.7 percent over the year, while Canterbury asking prices more than doubled.
Realestate chief executive Sarah Wood said the numbers showed the disconnect between what sellers wanted and where their market was headed.
“Average asking prices have trended downwards over the last 12 months, but we are hearing from agents that many sellers are still expecting prices above where the market is in their region.”
A raft of housing market reports have catalogued the decline in house prices over the past year with forecasts that the decline has further to go.
Wood said prices had dropped in two out of every five houses listed last year, well above 2021’s level.
“This reflects the state of the current market and the requirement for vendors to price their property based on what the market is willing to pay,” she said.
The number of listings on the website fell 4.7 percent last year to 103,000, which reflected the uncertainty that had arisen amid falling prices, rising interest rates, difficulty in getting finance, and inflation.
“As a result, some people may have held off on listing their property for sale, which is not uncommon when the economic environment is in flux,” Wood said.
However, based on past history, the market would rebound some day, she said.
“If you wait long enough, we will be talking about skyrocketing prices when the cycle swings around again.”
By Stephen Johnson, Economics Reporter For Daily Mail Australia
14:52 08 Feb 2023, updated 14:55 08 Feb 2023
- Aussie Home Loans founder sees house prices rising
- John Symond said it would occur in 2024 as rates cut
Aussie Home Loans founder John Symond predicts house prices will start rising again in 2024 as interest rates go back down, slammed the Reserve Bank boss for being a failure, and says baby boomers had it much than today’s borrowers.
The RBA’s latest quarter of a percentage point increase has taken the cash rate to a new 10-year high of 3.35 per cent – with Governor Philip Lowe signalling further increases in coming months.
Three of Australia’s Big Four banks – Commonwealth, Westpac and ANZ – are now expecting the RBA to raise rates two more times to a new 11-year high of 3.85 per cent.
But Mr Symond, who founded Aussie in 1992, said the RBA would be forced to cut rates in 2024 to ward off a steep economic downturn, and that would cause house prices to rise again like they did in 2021 and early 2022.
‘I’m confident that this time next year, house prices will be stronger than they are now,’ he told Daily Mail Australia.
Mr Symond said the lead-up to rate cuts at the end of 2024 would be a signal to buyers to get back into the market.
‘Once they start coming off again, which probably will be towards the end of next year, mid to the end of next year and you see rates edging down by half a per cent, that will be a signal to home owners “we’ve got to have a hard look at this”,’ he said.
The Commonwealth Bank is expecting the RBA to cut rates by 0.5 percentage points in the December quarter of 2023, followed by two more rate cuts by the end of June 2024.
Mr Symond did not expect such a rapid reversal, and thought rate declines would not occur until late 2024 when the current rate squeeze would have caused a sharp drop in consumer spending, possibly triggering a recession.
‘If they continue going up over the next six months, they are taking that risk,’ he said.
‘I disagree with the governor when he said that interest rate rises aren’t felt straight away – Australia unlike Europe and the US, we’re a very, very, very housing-centric country and as soon as there’s an interest rate rise, it’s felt immediately.’
Just as rate rises had a sudden impact, Mr Symond said future rate reductions would also prompt a rapid re-investment in housing, with consequent price increases.
Upmarket suburbs near the water in interest-rate sensitive markets like Sydney would be likely to bounce back first, like they did in late 2020 when rates were cut to a record-low of 0.1 per cent.
‘The upper areas of anywhere near water, they will be more resilient in my opinion than other suburbs,’ Mr Symond said.
Mr Symond, who pioneered non-bank lending three decades ago, predicted that when rates were cut in 2024, bank variable rates would drop by less than the RBA cash rate easing – as occurred in late 2008 during the Global Financial Crisis.
‘Interest rates, when they start dropping, you might find some of the banks might not drop the whole Reserve Bank amount,’ he said.
That’s because the banks and non-bank lenders source about 40 per cent of their funding from global money markets instead of from the Reserve Bank of Australia.
The banks’ global borrowing costs could mean they will likely be slow to pass on the full rate reductions to mortgage holders.
But he said the banks would be unlikely to raise variable rates through 2023 in excess of RBA moves, regardless of what their borrowing costs might be.
‘In this environment when interest rates have gone up so sharply, in such a short period of time, the banks would not be game enough – they’d get slaughtered both media and from customers,’ Mr Symond said.
When it came to the performance of the Reserve Bank, Mr Symond was scathing of Dr Lowe for promising in 2021 rates would stay on hold until 2024 only to have since raised them nine times.
‘The guy obviously knows his stuff but in this particular aspect of his job, it’s very unfortunate that this aspect is a very, very big and sensitive area of his role, he got it so wrong,’ he said.
‘On that, you’d have to mark him as a fail.’
Inflation last year surged by a 32-year high pace of 7.8 per cent, a level more than double the RBA’s 2 to 3 per cent target, which Mr Symond said made rate cuts unlikely in 2023.
‘I’d be more confident rates will come off during 2024, maybe mid to later, than I am this year,’ he said.
The man who fronted Aussie Home Loans TV commercials during the 1990s also had a message for older Australians saying they did it tougher than young borrowers today, with interest rates hitting 17.5 per cent 33 years ago.
Houses really are much dearer
SYDNEY: Median house price of $220,628 cost 5.7 times an average, full-time salary of $30,966 after a 20 per cent deposit in November 1992.
The mid-point house price of $1,205,618 in January 2023 was 10.4 times an average full-time salary of $92,030 after a 20 per cent deposit.
MELBOURNE: Median house price of $156,628 cost 4.04 times an average, full-time salary of $30,966 after a 20 per cent deposit in November 1992.
The mid-point house price of $900,107 in January 2023 was 7.8 times an average, full-time salary of $92,030 after a 20 per cent deposit.
Sources: CoreLogic, Australian Bureau of Statistics
The entrepreneur, who paid 21 per cent interest on his mortgage, said that those ‘boomers’ were able to buy houses at much lower prices as a percentage of average income.
‘The ’87 stock market crash caused a lot of pain for five or six years but take that away, baby boomers had it pretty good,’ he said.
‘Housing was more affordable, baby boomers didn’t have to go to war – there was some conscription but the percentage of baby boomers who went to Vietnam is very tiny and I think the baby boomers’ era was a golden era.
‘I remember when I was a young articled clerk in law, the average price of a house in the seventies was around 50 grand – when I say it was easier, less people got home loans then because money wasn’t a commodity like it is today where banks are borrowing offshore against their balance sheets.’
In November 1992, Sydney’s median house price of $220,628 was dear but an average, full-time worker on $30,966 with a 20 per cent deposit owed the bank 5.7 times their annual salary.
Little more than three decades later, Sydney’s mid-point house price of $1,205,618 is so expensive an average, full-time worker on $92,030, with a deposit, would have a dangerous debt-to-income ratio of 10.5.
That also followed a 15 per cent plunge in the year to January which barely unwound the 27.7 per cent surge during the pandemic, CoreLogic data showed.
The Australian Prudential Regulation Authority considers anyone owing more than six times their annual salary as over-committed.
Mr Symond sold the remainder of his stake in Aussie to the Commonwealth Bank in 2017, 25 years after being the head of Australia’s first non-bank lender.
Financial deregulation allowed lenders to source funding from overseas instead of having to rely on customer deposits to finance home borrowing.
2023 doesn’t look nearly as bleak as consensus economic forecasts and financial news reports suggest.
Photo via Pexels
A recession in 2023 seemed to be the consensus coming into the new year. That is no surprise, given that last year delivered the highest rate of inflation, the most monetary tightening in four decades, and an inverted yield curve. Strong January economic data—especially the U.S. employment report—may cause many forecasters to change their minds or delay the timing of an expected downturn to later in the year. But if this cycle ends up being designated as a recession, it’s already been underway for many months and will probably be over by the spring.
Recessions are typically generated by sharp declines in interest-rate-sensitive sectors, like housing and manufactured goods, and we have been experiencing that for quite some time.
- Housing is clearly in a recession that began almost a year ago. Mortgage rates more than doubled, and home sales have declined for 11 consecutive months—amounting to a cumulative drop of nearly 40 percent. House prices and rents have been falling since last summer.
- Consumer spending on goods in real (inflation-adjusted) terms peaked in mid-2021. This followed a surge when many services such as travel and dining at restaurants were off-limits, forcing people to spend a lot more time at home. The decline accelerated toward the end of last year following consumers re-engaging in those services and a huge rise in interest rates.
- Retail sales in November and December plunged at a double-digit annual pace, forcing retailers to discount items to eliminate excess inventories, cancel expansion plans, and reduce their workforce.
That is what happens during recessions. The technology sector is also contracting following a COVID-induced boom in the demand for tech services like online shopping, food delivery, streaming services, and remote work and video conferencing. Just like the retail industry, tech companies expanded their capacity to an extent that turned out to be excessive.
Normally, all of that would be enough to crash the economy. But the COVID experience delivered several unusual developments that allowed the economy to hold up unusually well:
- A combination of factors—including early retirements, less immigration, people either sick or caring for someone who is, and a dearth of childcare services—produced a massive shortage of labor. Job openings peaked at a record 11.5 million and there are still 11 million openings compared with less than 6 million people unemployed. That has allowed the economy to continue generating strong job growth even as labor demand weakens. As a result, household income isn’t getting hit nearly as hard as it usually does, mitigating the spread from the cyclical sectors to the rest of the economy.
- Household and business balance sheets have remained relatively healthy, supported by huge income and wealth gains generated by unprecedented monetary and fiscal stimulus. Households were able to build up a huge stock of excess savings that they are still digging into to support spending. In addition, consumers and businesses did not take on excessive leverage and debt to the degree usually seen in the later stages of economic recoveries.
- Energy and other commodity prices have fallen sharply, contrary to the experience during the great inflation of the 1970s and early 80s. The decline in gasoline and natural gas prices has boosted household purchasing power, while sharp drops in lumber and steel prices have helped keep production costs under control.
The path of the economy going forward will be determined largely by the future path of inflation and how central banks respond to it. Fed tightening is working: the cyclical sectors are getting clobbered, and most asset prices—including stock and bond prices—have fallen significantly. Most important, inflation has diminished at an extraordinarily rapid pace.
The oft-quoted year-on-year deceleration does not capture the true extent to which inflation has collapsed in recent months.
- Between June and December of 2022, headline CPI dropped from 9 percent to 6.5 percent. However, overall prices have been flat for the past 2 months (i.e., zero headline inflation).
- Much of the recent weakness in inflation is due to the sharp drop in energy prices, but that may not continue.
- However, core (excluding food and energy) inflation—the Fed’s focus—has also decelerated impressively. Core CPI has been running at an annual rate of only 3.1 percent over the past three months, while the core PCE—a different measure of inflation that the Fed officially targets—was up 2.9 percent, already coming close to the Fed’s objective of 2 percent.
- Even more encouraging is that it is likely to slow even further. Shelter costs—which account for over 40 percent of core inflation—ran at an annual rate of over 9 percent during this same period but will likely decelerate going forward. Federal housing agencies, brokerage listing services, and other private data sources show that both house prices and rents have been falling since last summer. This will be captured eventually in the official inflation data, which uses an average of rents over the previous 6 months to estimate monthly changes in shelter costs.
With that kind of progress on inflation having already occurred and with more in the pipeline, the Fed hiking regime should be close to an end. Market pricing suggests that the Fed will complete this hiking cycle by the spring with a Fed funds rate of around 5 percent or a bit higher, which seems reasonable. But market expectations of rate cuts in the year’s second half will probably not be realized.
- The cyclical sectors of the economy are close to a bottom, making a significant deterioration in the economy later this year unlikely.
- On the contrary, a bounce in the economy beginning in the spring or summer seems more probable than a further deterioration. If the recent drops in mortgage rates and house prices are maintained, a pickup in sales sometime later this year would not be surprising. Meanwhile, excess inventories in the retail industry will probably be eliminated in no more than a few months.
- While inflation is coming down much more quickly than expected, the Fed will want to ensure that it stays that way and doesn’t pick up again.
All of these things have implications for the financial markets. Current stock prices seem broadly consistent with a very mild economic downturn, as the cumulative decline since the beginning of last year is significant but less than the typical recession. The S&P fell almost 20 percent last year after a 27 percent surge in 2021. So far, it’s up this year for a net peak-to-trough decline of around 15 percent. That compares with a mean drop in the S&P during recessions of 29 percent. That said, it seems too early to be overly bullish.
- Most valuation measures suggest that stocks are not cheap, and a strong economic rebound seems unlikely anytime soon.
- In addition, profit margins have peaked, and bond yields are likely to remain considerably higher than they were a few years ago.
Bond yields are trending higher than they were before the pandemic, and that is consistent with the surge in inflation and higher Fed policy rates. The yield on 10 U.S. Treasuries is currently at the bottom of the 3.5-4.25 percent range that they have been in since the fall. While that is well above the 1.5-3 percent range that persisted for a decade before COVID, the change in economic fundamentals since the pandemic suggests that bond yields are likely to end up closer to the top end of that range or even a bit above it.
- The U.S. budget deficit is significantly larger, and the Fed will not resume buying bonds again for the foreseeable future.
- Zero policy rates are a thing of the past.
- While inflation is on a significant downtrend, structural changes suggest it will not settle as low as it was pre-pandemic when inflation was often below the Fed’s target of 2 percent.
- International trade has peaked, and companies no longer use cost as the sole factor in deciding where to produce or buy inputs from. Instead, they are diversifying their supply chains and placing more emphasis on reliability and safety.
The U.S. is one of many countries where economic prospects are outperforming consensus forecasts.
- China recently announced a sharp reversal of its zero-COVID policy, setting the stage for a rebound from a period of unusually slow growth.
- Europe’s outlook has also brightened considerably, as energy shortages resulting from the war in Ukraine have been much less severe than was feared. The weather has been warmer than anticipated, and countries have been able to build oil and gas stockpiles from non-Russian sources. As a result, natural gas prices have fallen back below pre-Russian-invasion levels, a very positive surprise. This means that the deep recession forecast for the Euro area no longer looks likely.
The bottom line is that 2023 doesn’t look nearly as bleak as consensus economic forecasts and financial news reports suggest. The inflation surge is evaporating quickly, Fed rate hikes are near an end, and a recession—if it ends up being designated as such—has already occurred, and it’s much less painful than usual.