The Big Picture – Febuary 8th 2023

Published Feb 8, 2023

Last week’s surprise payroll data gave further support to the Fed’s position that their work isn’t done and won’t be for quite some time. However, the data might not be an accurate reflection of employment conditions, and many economists see large seasonal and other “adjustments” as grossly inflating the report. But there’s no doubt the headline-grabbing numbers are providing air cover for the Fed to hold firm. However, the unemployment rate is a lagging indicator making it a poor gauge of future recession risk; it usually bottoms just before recessions and peaks just after. Those who foresee a recession and Fed easing will probably be proven right (eventually), but those who foresee it being a “soft landing” shouldn’t pin their hopes on last week’s data.

At 70% of GDP, consumer spending must remain strong for the landing to be soft. A good indicator of the strength of the consumer is credit card usage; higher usage indicates less capacity for spending. Card balances dropped in the early months of the pandemic as households received stimulus money, but balances have been rising ever since. Outstanding credit card balances are up 30% from pandemic lows and are now 10% higher than before the pandemic. Clearly, the stimulus money is spent, and consumers are tapping credit cards to maintain spending. 

More debt, by itself, doesn’t necessarily mean trouble. But as the percentage of household income going to service debt increases (which it is as rates rise and incomes stagnate), consumers must eventually change their buying habits. Moreover, if consumers can’t rollover debts as they mature (revolving debt, auto loans, etc.), they can run into serious liquidity problems, and recent surveys of bank lending officers show a sharp tightening of lending standards for credit cards and auto loans (and business loans too), a pattern that often precedes recession.

There are clear indications that supply chain issues are being resolved, and inflation is coming down. For example, the costs of moving freight are back to pre-pandemic levels, and the price of oil has dropped nearly 40% from last June’s highs. My view is that a recession is unavoidable and, combined with deflation, will give the Fed ample reason to reverse course. But the Fed is always late; they were late to deal with inflation, and they will be late to deal with the recession/deflation to come, and they do not want to be seen as accommodating financial markets by moving too early. And the more the policy shift is delayed, the greater will be the amplitude of the next cycle which won’t be a terrible outcome for home buyers, but it does require patience.

What I find most interesting these days is that despite the rapid rise in rates, the reshaping of the yield curve, and accompanying corrections in some asset classes (crypto, tech stocks, etc.), nothing has “broken” (yet). There have been no ‘80s-like bank failures, no ‘90s-like hedge fund blow-ups, and no (knock-on-wood) 2008-like credit/liquidity fires. Have we learned from past mistakes, or is it just too early in the cycle? Time will tell.

Housing, the bedrock of the economy, remains astonishingly strong, all things considered. Listings are still about 17% behind this time last year but show acceleration from Jan 1, when new listings were 23% behind last year. And the median sale price per square foot has remained constant at $192. Buyers still want homes and are eagerly watching for any rate drop, which should help to blunt the impact of weakening demand if/when recession comes.

That’s the big picture this week.

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