Monetary Policy, Interest Rates and Inflation
Economic Growth and Jobs
The Bureau of Economic Analysis’ advance estimate of first quarter 2015 real growth (economic growth rate minus the inflation rate) came in at a paltry 0.2 percent – that is, significantly less than one percent. This was a shock to the system, mostly blamed on bad weather in the Midwest and Northeast. The Bureau did caution that the data were still incomplete and are subject to further revision, which should be upward. However, the outlook among economists is what I would call “lukewarm” optimism. The fourth quarter 2014 real GDP growth was only 2.2%, although the third quarter increase was an outstanding 5%. The fourth quarter rate is more in line with what economists have been expecting as a yearly average. The first quarter lower real GDP growth was due to a deceleration in personal consumption; and, declines in exports, nonresidential fixed investment, and state and local government spending. These “negative” factors were partly offset by declines in imports, a rise in private inventory investment, and growth in federal government spending. Because this first quarter number was weak, many analysts are still concerned that growth is too slow. Although most economists are somewhat bullish on U.S. growth, significant international barriers remain. These include slow to negative growth in the Eurozone countries and slowing growth in China, with its debt and real estate bubbles. However, the April payroll employment report was extremely positive with 223,000 (SAAR) new non-farm jobs – a big improvement over March’s pathetic 85,000 new jobs. Also, the most recent household survey for the unemployment rate came in at a new low of 5.4% -- the lowest rate since the great recession started. However, this rate is now at a level where many economists consider the economy close to “full employment” and they are fearful that further declines in unemployment may set off wage inflation. Most economists feel the labor market is getting stronger but job losses in mining and extraction industries (i.e., oil-and-gas) are still occurring; although, the rate at which frackers are shutting down rigs is slowing.
The Fed has slightly modified its language regarding future interest-rate hikes. It is indicating there will be increases but very vague on the exact timing. Speculators, of course, are betting, with most bets focused on the September meeting. Inflation has been trending down due to declines in energy prices, Europe is heading into another recession, and China has a housing bubble and slowing growth rate. China is lowering its internal bank interest rates, trying to support the economy. And, the European monetary authority is just starting to apply policies similar to the Fed’s quantitative easing policies of recent years. Inflation has been and still is quite tame. The overall personal consumption expenditures index (the Fed’s preferred inflation measure) over the past year was up only 0.3%. Furthermore, when food and energy were subtracted out, that residual “core” inflation was only 1.3% over the past year (because gas and oil prices were declining). Accordingly, regardless of when the Fed pushes on short-term rates, it is likely to go slow to avoid derailing our modest prosperity. One salubrious outcome of low inflation is that mortgage rates are still relatively low by historical standards. In the first week of May, Freddie Mac national surveys put the 30-year fixed conforming mortgage rate at 3.80% (up from 3.75% in the first week of March). The 15-year fixed averaged 3.02%, the 5/1-year ARM came in at 2.90% and the 1-year ARM was 2.46%. It is increasingly likely that the Fed will not push up interest rates over the next two months, but will wait until late summer or fall. The U.S. stock markets continue to maintain high values although volatility has persisted with frequent 100- to 200-point daily changes in the Dow Jones industrials. While some research shows that stocks can still hold on even with rising interest rates, it is bonds that are the most vulnerable.
The Bottom Line
The recent improved job performance indicates the U.S. economy should grow at about a 2% rate over the next year. Interest rates will rise but at a slow rate – short-term rates at 25 basis points per quarter (one percent per year). However, it will take another year of solid performance to get us back to the pre-recession levels of well being. The world is watching the Eurozone and China. So far, national sales and price numbers show that this will be a pivotal year for the economy and our local housing market. Currently, for both Montgomery County and the District of Columbia, sales are up double-digits, with prices up or only slightly declining, depending on the market segment. While only economists would find comfort in these results, given the scarce inventory, GCAAR members are finding a way to get properties sold.
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CAPITAL AREA REALTOR® • May/Jun 2014 CAPITAL AREA REALTOR® • May/June 2015