HIGHLIGHTS OF THE WEEK

  •  Financial markets jitters have eased somewhat this week as concerns about emerging countries have temporarily subsided, helped in part by a lower U.S. dollar.
  • Economic data was mixed. U.S. business investment remained upbeat in July, with new orders of capital goods (ex. aircraft) rising 1.4% m/m. Meanwhile, the housing market disappointed yet again in July.
  • On the policy front, FOMC meeting minutes and a speech by Chairman Powell noted the recent strength in economic performance and confidence in the outlook, signaling continued gradual interest rate increases.

 

FOMC Signals Continued Gradual Rate Hikes

Aside from the political storm in Washington, this was a relatively quiet week. Data-wise, new and existing home sales and durable goods orders were on the docket. On the policy front, highlights included minutes of the FOMC meeting and the central bankers’ conference in Jackson Hole. On the trade front, new China-U.S. trade talks failed to produce any meaningful results, while the latest batch of tariffs targeting $16 billion of each other’s goods came into effect. Despite the deepening trade spat with China, U.S. business investment has remained upbeat in July, with new orders of capital goods (ex. aircraft) rising 1.4% m/m, up 8.5% from a year ago.

Financial markets’ jitters eased somewhat this week as concerns about emerging countries have temporality subsided. This was helped by the lower U.S. dollar, which has reversed some of its recent strength following president Trump’s comments that he was “not thrilled” about the Fed’s interest rate increases.

Like it or not, the latest FOMC meeting minutes have signaled that the committee continues to view gradual interest rate increases as appropriate, so long as the economy evolves in line with its expectations. For now this continues to be the case. The committee noted the recent strength in economic growth and expressed confidence in the outlook, despite downside risks stemming from trade tensions. Taken together, these comments signal another 25 bp rate hike in September, and likely one more in December. At Jackson Hole, Chair Powell reiterated his support for the gradual pace of monetary policy normalization and defended the Fed’s current approach.

While the U.S. economy, broadly, is running at full throttle, the housing market has hit a speed bump (see Chart 1). Both new and existing home sales failed to make headway in the first half of the year, and this week’s data suggests that the softness has extended into the third quarter. Existing home sales declined for a fourth consecutive month  in July (-0.7% m/m), while sales of new homes slipped by 1.7% m/m, suggesting residential investment could again weigh on GDP growth in Q3.

It is hard to square the housing market underperformance amid strength in other sectors of the economy as well as rising employment and incomes. Most commentators chalk tepid sales to low inventory, particularly in the entry-level segment. While new construction has been rising, it has been skewed toward higher end of the market with houses getting progressively larger during the recovery. Square footage of the median house was 13% larger in 2017 than it was back in 2004 (see Chart 2). Rising home prices and mortgage rates, which are up nearly 60 basis points since last year, have also dented affordability. These and other headwinds are likely to persist in the near term, however, but there are also some silver linings: price growth appears to be slowing and housing inventory finally stopped shrinking in July (on a y/y basis), stabilizing for the first time since the end of 2014..

Ksenia Bushmeneva, Economist | 416-308-7392

 

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