Things are moving fast in the U.S. economy, so we want to provide a mid-quarter update.
We continue to expect an upside surprise in Q4 economic growth, based on the strength of consumer-driven Q3 growth. The holiday spending season should carry that strength through the end of the year, buoyed by continued dependence on credit card spending. It should also be noted that 401k hardship withdrawals are at historically high levels this year, which is also contributing to spending, but is not a healthy sign.
Yield Curve and Monetary Policy
The two-year Treasury yield is down 20 basis points (bp) since quarter-end as of this writing, and the ten-year yield is down 14 bp. As a result, the current inversion in the yield curve is exactly the same as it was at quarter-end, at 44 bp, after narrowing to just 13 bp in late October, which was the flattest the curve has been since shortly after the current inversion began in mid-2022. So the yield curve continues to price in an economic downturn; the question remains when it will commence.
The FOMC held rates steady at its November 1 meeting, and Fed funds futures have priced in zero probability of a rate hike at the final meeting of the year, scheduled to conclude December 13. The futures market continues to price in easing beginning as early as May of 2024, based on headwinds facing the economy. However, there is an emerging view among many observers – ourselves included – that the Fed’s policy theme in 2024 may be “higher, longer” rather than an immediate shift to accommodation.
Part of the reason for this is the continued threat of inflation. While the October CPI print showed a drop in the headline number to 3.2% year-over-year, inflation remains above the Fed’s preferred target. Also, fiscal policy continues to place pressure on price levels. Lawmakers agreed to a stopgap bill to extend government funding through January for some items and February for others; the plan includes no spending cuts, but also doesn’t include the President’s requested aid for Ukraine and Israel. If that spending is eventually approved, that will add to inflationary pressures. And there are concerns that in a Presidential election year, any signs of economic weakness will be met with fiscal stimulus in an effort to win votes, a move that would pit fiscal policy against monetary policy, and leave the Fed with little choice other than to maintain a “higher, longer” posture.
Housing Market Trends
The S&P/Case-Shiller 20-City Composite Home Price Index is up 2.2% year-over-year as of August, the most recent available data. The July release was the first in which the index posted a year-over-year gain since February. Eighteen of the 20 markets in the composite index posted monthly gains in August, after three consecutive months in which all 20 markets recorded gains. Eight of the 20 markets remain negative on a year-over-year basis.
The 30-year fixed mortgage rate has retreated a bit in recent weeks with the decline in the ten-year yield, but it remains near 8%, the highest level since 2000. Existing home sales remain depressed as homeowners are reluctant to sell in the current rate environment, but new home sales are up 34% year-over-year, which is the sole driver of the increase in home prices, as existing home inventories are at historically tight levels.
The combination of still-rising prices and the highest mortgage rates in more than two decades is pricing many buyers out of the market. But more problematic is the fact that some buyers may be over-leveraging themselves into home purchases at current mortgage rates in hopes that rates will fall, enabling them to refinance at what they hope will be a return to rates they perceive to be “normal.”
The current level of mortgage rates is actually approximately equal to the long-term historical average. However, the fact that we haven’t seen rates this high for more than 20 years means that an entire generation of Americans perceives that mortgage rates between 2.75% and 6.50% are the norm. A first-time buyer just out of college hasn’t seen mortgage rates this high in his lifetime, and a 45-year-old who’s only been paying attention to mortgage rates since she was in college, now looking to trade up to that next home, hasn’t seen mortgage rates this high since she first began looking at rates.
A recent study conducted by U.S. News found that 84% of Americans who bought a home in the last year expect to be able to refinance within the near future – nearly half believe they’ll be able to refinance within the next year, and about three-fourths believe they’ll be able to refinance within two years. However, more than 40% of those surveyed would need rates to fall to between 5.5% and 6% in order to be able to refinance, a drop of 250-300 bp from current levels. About 20% would need to see a rate below 5%. And – most troubling for lenders – 13% said they won’t be able to make payments at their current rate if they’re not able to refinance.
Labor Market
Unemployment edged up to 3.9% in October, the highest rate since the beginning of 2022. Payroll growth slowed to 150k jobs, missing expectations, and September’s gain was revised lower, as has been the pattern for several months. Payroll growth over the last five months has averaged less than 200k, vs. nearly 300k over the first five months of the year. The labor market remains below equilibrium compared to levels we would expect had the covid shutdown not occurred. Average hourly earnings also dropped in October, to 4.1% year-over-year. That means that real wage gains are barely positive.
Initial jobless claims have spiked over the most recent four weeks as of this writing, jumping from 200k to 231k, the highest level since August. We will likely see even higher claims after the holiday retail season ends. Continuing claims are also trending higher, having risen in each of the last eight weeks, from 1.66 million to 1.87 million, the highest level in nearly two years.
Outlook
Based on the labor market, the economy shows signs of weakening. In addition, we question whether home price gains can be sustained in the current rate environment. The combination of a softening labor market, homeowners potentially facing difficulty in making payments, increasing credit card delinquencies, and growing 401k hardship withdrawals are all warning signs for lenders.
At the same time, fiscal policy may prevent monetary policymakers from providing accommodation to provide relief in the face of a weakening economy. A soft landing may be less likely than we anticipated at the beginning of the current quarter, but an immediate shift to easing by the Fed remains in doubt.
Credit unions should be prepared for a continuation of the current margin and liquidity challenges. They should also keep a careful eye on delinquency trends, and be prepared to adjust underwriting criteria, if they haven’t already. In addition, they should be prepared to work with members who may face difficulty in meeting their obligations, especially members who took out mortgage loans over the last year who may find themselves unable to refinance in the time frame they expect. (And don’t forget that 46 million Americans were required to resume repaying student loans in October.)
Learn More
These are not insurmountable challenges, and there are strategic opportunities in every downturn for those credit unions willing to take educated, informed risks. Prudent and proactive risk management is the key to being prepared as 2023 comes to a close and 2024 unfolds, and Rochdale can help your credit union face that future with confidence. For more information, contact us at sales@reimaginerisk.com.