Tag: Federal Reserve

Savings, Spending, and The Fed’s Challenge

Posted on by aweinsoff@channelchek.com
Image Credit: Federal Reserve (Flickr)

Consumer Spending, While Draining Bank Accounts, Could Prolong Fed Tightening

Economics is a social science, and as such, it’s based largely on human behavior, with mathematical models then used to assess decisions and predict outcomes. The U.S. government published consumer savings rates during the first week of October. The results are in line with what economists would expect when the masses’ ability to live the same lifestyle as before is challenged by either high inflation, fewer jobs, or both. There is a delayed effect on consumers’ behavior in the face of higher prices, this is impacting debt levels and savings rates. Also, the upper echelons of earners are not as inclined to cut back, which could make the Fed’s job trickier.

One recognized principle of economics that has proven true throughout history is related to adding stimulus and taking stimulus away and changes in spending. When more money is put in the hands of the citizenry, whether by tax decreases, or direct stimulus checks, that money will be put to work (spent), fairly quickly. Especially by those whose lives would most be impacted, those with stricter budgets. When discretionary income decreases or prices rise, consumers don’t react as quickly. We can think of the reasons why in this way; one is that fixed costs can’t change as quickly if income goes down as they can if the ability to spend increases. The other reason is that we tend to adjust on the downside more slowly while still doing many things that we can not as easily afford to do.

Put another way, we accelerate spending quickly when money is more available than we brake when it becomes less available; in fact, households tend to take their foot off the accelerator, even if it keeps them spending at a pace that puts their household finances in jeopardy.

The Post-Covid Economy is Confounding

At the turn of the year, consumers were thought to have built up about $2.4 trillion of excess savings during the pandemic. Many economists argued the economy would be able to avoid a recession, even as the Fed aggressively raised interest rates. Many of these economists, joined by business owners and investors, are changing their odds of a soft landing; many are still expecting a quick rebound as consumers are believed to have exited the pandemic in strong financial shape.

New data about U.S. consumer savings, however, and a look at consumer finances suggest that they may be overestimating the long-term resilience of consumers.

Last week the FDIC shed some light on savings rates, and the Bureau of Economic Analysis (BEA) provided information on Personal Consumption Expenditures (PCE).

Downward revisions to the savings rate indicated that households had used a much bigger proportion of pandemic savings than seen in previous data, and the starting point is now believed to have been smaller.

According to previous data, through July, households had spent about $270 billion, or 11% of peak excess savings of $2.4 trillion. The updated data show that the peak savings stock was $2.1 trillion. Also, about $630 billion, or 31%, has already been spent.

The  $1.4 trillion that is in savings is still no small amount of money. But, Nancy Lazar, chief global economist at Piper Sandler, told Barron’s that it’s not enough to prevent credit-card borrowing from ballooning and consumer delinquencies from climbing. Credit-card loans are now 6% above their pre-pandemic high. With rates climbing, 60% of revolving debt is extending out and being carried for one year or longer.

“Delinquency risk is rising, especially for low-end consumers who have exhausted their excess savings,” Lazar said.

Lazar told the journal that she calculates the composite 30-day delinquency rate across big financial institutions,  like American Express (AXP), and JPMorgan Chase (JPM), to have risen to 0.82% at the end of August from 0.78% a year earlier. More evidence comes from data from Kroll Bond Rating Agency that showed subprime auto-loan delinquencies are climbing higher, and even prime auto-loan delinquencies are moving up. And Affirm Holdings (ticker: AFRM), which is a buy-now and pay-later company, reported a 290% year-over-year increase in its provision for credit losses.

What Fed Governors Want

Is this “bad news” actually “good news” for stocks and bonds? If consumers have lower means than thought when the Fed began its tightening, this could give hope to those investors that are looking for the Fed to pivot back to an easier policy stance. But economics seldom plays out with just one or two inputs.

Another piece of information economists look at is the Labor Department’s Consumer Expenditure Survey data. Overall, 60% of consumption in the U.S. are from the top 40% of income earners. The lowest quintile, the lowest 20% of earners, those with less discretionary income, make up only 9% of consumption in the U.S.

So the Fed’s predicament has them needing to squelch the relatively high level of consumption of the top 40% that can still pay for the same lifestyle without reducing consumption, and at the same time not overly disrupt those that will feel the impact the most, the lowest 20% of earners in the country.

Take Away

It seems that in the broadest sense, the Fed has impacted consumption in the group that will impact consumption least. Those that would impact the pace of the economy and inflation most are not yet putting their wallets away.   This increases the degree of difficulty the Fed faces when working to bring inflation down to the 2% target.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.bea.gov/

https://www.bls.gov/cex/

https://www.kbra.com/sectors/public-finance/issuers

https://www.barrons.com/articles/consumer-savings-fed-problem-51665185301?mod=hp_LEAD_1

Do Low Mortgage Rate Homeowners Feel Handcuffed?

Posted on by aweinsoff@channelchek.com
Image Credit: Julie Weatherbee (Flickr)

Homeowners With Low Rates May Keep Inventories Low and Prices Stable

For many, the largest single asset they own is their home. While many investors are concerned about what rising interest rates may mean for investments in the stock market, homeowners are keenly aware that rates can directly impact home prices as most borrow to buy. The amount they can borrow is directly related to their cash flow, so the purchase price they can afford rises and falls with mortgage rates. This impacts demand and offer prices. But what does it do for the supply side of the pricing mechanism?

Rate Increases and Homes on the Market

Mortgage rates over the past year have risen from the low 3% range to the low 6% range for traditional 30-year loans. Typically the period in the rate cycle when mortgages begin to rise corresponds to a Fed tightening cycle, as it has in 2022. While rates were lower, buyers were able to afford “more house” and allowed sellers to push up asking prices – or in some cases, buyers would have had a bidding war driving up a home’s price.

As rates increase and it then costs borrowers more each month for the same price, buyers lessen. Home prices initially don’t decline as quickly as sellers would like as home sellers are stickier on the way down than they are on the way up. As with any investment, until you book your profit/loss, it’s just paper gains/losses. And homeowners don’t like to think of themselves as having “lost” thousands because their house once would have fetched more. So home buyers sit and wait, which in the past has caused inventories to increase. Eventually, there is capitulation among homeowners, and many houses hit the market with lower prices attached to them.

This has not happened yet during this rate cycle, and there is an underlying reason that may prevent it from happening. Existing homes are not entering the market as expected.

Homes for Sale are Scarce

The Wall Street Journal published an investigative piece on the real estate market and how Homeowners with low mortgage rates are stubbornly refusing to sell their homes because it would mean they’d have to borrow at much higher rates for wherever they may move. 

The Journal reported that housing inventories had risen somewhat from record lows earlier in 2022. But this is primarily because they aren’t selling as quickly. The number of newly listed homes from mid-August to mid-September fell 19% from the same weeks last year. This suggests that those that may have sold to move for any reason are staying put.

The explanation for this unexpected phenomenon is that most that have purchased or refinanced their homes in the past few years have historically low mortgage rates. Imagine having 2.75% locked in for 30 years and knowing that if you purchase the home in the next town with the extra bedroom, your rate will be 6.25%. Potential sellers are opting to make do.

Homes will always enter the market regardless of dynamics. People die, change jobs, get divorced, the kids move out, etc. But, if those who have the option not to move decide to stay in larger percentages than in the past, it could keep the inventory of homes for sale below normal levels. The low supply could keep home prices elevated.

Another option someone who would like to move has is to rent. Rents have been quite high; this would serve to reduce the upward pressure on tenants. It would also keep homes from entering the market, allowing them to retain values better than might be expected with higher mortgage rates.

The scarcity of homes on the market is one of the primary reasons home prices have retained their high levels, despite seven straight months of declining sales in a period when interest rates have roughly doubled since December.

Handcuffed by Low Rates

There is a term used on Wall Street for employees that feel they can’t leave their company because they have vesting interests worth too much. For example, my friend Katherine was granted stock options from her company, the ability to exercise the options vested over a few years. At any point, if she left to take another position, or as she told me she wanted to do, raise children, she would have been leaving a huge sum of future stock or cash behind. Homeowners with mortgages near 3% when rates are near 6% have found their situation similarly handcuffs them and drives greed-based behavior.

Today Millions of Americans are locked in historically low borrowing rates. As of July 31, nearly nine of every ten first-lien mortgages had an interest rate below 5%, and more than two-thirds had a rate below 4%, according to mortgage-data firm Black Knight Inc. About 83% of those mortgages are 30-year fixed rates.

Can it Last?

Homeowners looking for more space are now more likely to add on than they had been before. For those looking to scale down, they may find that it isn’t worth it. In an analysis of four major metro areas—Atlanta, Chicago, Los Angeles, and Washington—Redfin found that homeowners with mortgage rates below 3.5% were less likely to list their homes for sale during August compared with homeowners with higher rates.

It is difficult to predict any market, and there is very little history to look back on when rates have been increased this quickly. Sam Khater, the chief economist for Freddie Mac, told the Wall Street Journal an analysis he did in 2016 of past periods of rising rates showed a decline in sales in which a buyers’ prior mortgage rate was more than 2% below their new mortgage rates. But there was no change if the difference between the rates was less than two percentage points. We are likely to retain more than a 2% margin for some time based on how low homeowners’ mortgages now are. Perhaps until many of the loans are paid off.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.wsj.com/articles/after-years-of-low-mortgage-rates-home-sellers-are-scarce-11663810759?mod=hp_lead_pos3

https://www.blackknightinc.com/data-reports/?

The Markets Still Don’t Understand How the Current Tightening Cycle is Different

Posted on by cpatches
Source: Federal Reserve (Flickr)

The Hows and Whys of a Tightening Federal Reserve

The Federal Reserve (the Fed) will be holding a two-day Federal Open Market Committee (FOMC) meeting next week that ends on September 21. After the FOMC meeting, it is the current practice for the Fed to announce what the target Fed Funds range will be. That is, make the public aware of what overnight bank loan rate the Federal Reserve will work to maintain through open market operations.

Open market operations is the Federal Reserve buying and selling securities on the open market. The purchases are restricted to debt or debt-backed securities so that interest rates are impacted. It’s through controlling interest rates that the Fed works to maintain a sound banking system, keep inflation under control, and help maximize employment. Purchasing securities through its account puts money into the economy, which lowers rates and helps stimulate economic activity. Selling securities takes cash out of circulation. This tightens money’s availability and can also be accomplished by letting the financial instrument mature and then not replacing them with an equal purchase.

Quantitative Easing

If the Federal Reserve hadn’t put money into the economy, they’d have nothing to sell or allow to mature (roll-off). With this in mind, the natural position of the Federal Reserve Bank is stimulative.

Currently, the Fed owns about a third of the U.S.Treasury and mortgage-backed-securities (MBS) that have been issued and are still outstanding. Much of these holdings are a result of its emergency asset-buying to prop up the U.S. economy during the Covid-19 efforts.

Two years of quantitative easing (QE) doubled the central bank’s holdings to $9 trillion. This amount approximates 40% of all the goods and services produced in the U.S. in a year (GDP). By putting so much money in the economy, the cost of the money went down (interest rates), and the excess money, without much of an increase in how many stocks, bonds, or houses there are, made it easier for people to bid prices up for investible assets. For non-investments, the combination of easy money while lockdowns slowed production became a recipe for inflation.

Inflation

Inflation is now a concern for the average household. The Fed, which is supposed to keep inflation slow and steady, needs to act, so they are changing the current mix. It is making these changes by taking out a key inflation ingredient, easy money. This same easy money has been a contributor to the ever-increasing market prices for stocks, bonds, and real estate.

The overnight lending rate the Fed is likely to alter next week is the policy that will create headlines. These headlines may cause kneejerk market reactions that are often short-lived. It is the extra trillions being methodically removed from the economy that will have a longer-term impact on markets. These don’t have much impact on overnight rates, their maturities average much longer, so they impact longer rates, and of course spendable and investible cash in circulation.

Quantitative Tightening

The central bank has only just started to shrink its holdings by letting no more than $30 billion of Treasuries and $17.5 billion of MBS, roll off (cash removed from circulation). They did this in July and again in August. The Fed then has plans to double the amount rolling off this month (most Treasuries mature on the 15th  and month-end).

This pace is more aggressive than last time the Fed experimented with shrinking its balance sheet.

Will this lower the value of stocks, crash the economy, and make our homes worth the same as 2019? A lot depends on market expectations, which the Fed also helps control. If the markets, which knows the money that was quickly put in over two years, is now coming back out at a measured pace, and trusts the Fed to not hit the brake pedal too hard, the means exist to succeed without being overly disruptive. If instead the forward-looking stock market believes it sees disaster, an outcome that feels like a disaster increases in likelihood. For bonds, if the Fed does it correctly, rates will rise, which makes bonds cheaper. You’d rather not hold a bond that has gotten cheaper for the same reason that you don’t want to hold a stock that has gotten cheaper. However, buying a cheaper bond means you earn a higher interest rate. This is attractive to conservative investors but also serves as an improved alternative for those deciding to invest in stocks or bonds.

Houses are regional, don’t trade on an exchange and unlike securities, are each unique. They are often purchased with a long-term mortgage. Higher interest rates increase payment costs on the same amount of principal. In order to keep those payments affordable, home purchasers may demand a lower price, thereby causing real estate values to decline.

Take Away

The Fed has told us to expect tightening. They were honest when they promised to ease more than two years ago; there is no reason not to plan for higher rates and tighter money. The overnight rate increases get most of the attention. Further, out on the yield curve, the way quantitative tightening plays out depends on trust in the Fed and a lot of currently unknowns.

Paul Hoffman

Managing Editor, Channelchek

Source

https://www.federalreserve.gov/