by Calculated Risk on 4/12/2018 11:30:00 AM

CR April 2018 Update: In 2013, I wrote a post "Predicting the Next Recession". I repeated the post in January 2015 (and in the summer of 2015, in January 2016, in August 2016, and in April 2017) because of all the recession calls. In late 2015, the recession callers were out in force - arguing the problems in China, combined with the impact on oil producers of lower oil prices (and defaults by energy companies) - would lead to a global recession and drag the US into recession.  I didn't think so - and I was correct.

I've added a few updates in italics by year.  Most of the text is from January 2013.

A few thoughts on the "next recession" ... Forecasters generally have a terrible record at predicting recessions. There are many reasons for this poor performance. In 1987, economist Victor Zarnowitz wrote in "The Record and Improvability of Economic Forecasting" that there was too much reliance on trends, and he also noted that predictive failure was also due to forecasters' incentives. Zarnowitz wrote: "predicting a general downturn is always unpopular and predicting it prematurely—ahead of others—may prove quite costly to the forecaster and his customers".

Incentives motivate Wall Street economic forecasters to always be optimistic about the future (just like stock analysts). Of course, for the media and bloggers, there is an incentive to always be bearish, because bad news drives traffic (hence the prevalence of yellow journalism).

In addition to paying attention to incentives, we also have to be careful not to rely "heavily on the persistence of trends". One of the reasons I focus on residential investment (especially housing starts and new home sales) is residential investment is very cyclical and is frequently the best leading indicator for the economy. UCLA's Ed Leamer went so far as to argue that: "Housing IS the Business Cycle". Usually residential investment leads the economy both into and out of recessions. The most recent recovery was an exception, but it was fairly easy to predict a sluggish recovery without a contribution from housing.

Since I started this blog in January 2005, I've been pretty lucky on calling the business cycle.  I argued no recession in 2005 and 2006, then at the beginning of 2007 I predicted a recession would start that year (made it by one month with the Great Recession starting in December 2007).  And in 2009, I argued the economy had bottomed and we'd see sluggish growth.

Finally, over the last 18 months, a number of forecasters (mostly online) have argued a recession was imminent.  I responded that I wasn't even on "recession watch", primarily because I thought residential investment was bottoming.

[CR 2015 Update: this was written two years ago - I'm not sure if those calling for a recession then have acknowledged their incorrect forecasts and / or changed theirs views (like ECRI and various bloggers). Clearly they were wrong.]

[CR April 2017 Update: Now it has been over four years!  And yes, ECRI has admitted their recession calls were incorrect.  Not sure about the rest of the recession callers.]

[CR January 2018 Update: Now it has been five years!]

Now one of my blogging goals is to see if I can get lucky again and call the next recession correctly.  Right now I'm pretty optimistic (see: The Future's so Bright ...) and I expect a pickup in growth over the next few years (2013 will be sluggish with all the austerity).

The next recession will probably be caused by one of the following (from least likely to most likely):

3) An exogenous event such as a pandemic, significant military conflict, disruption of energy supplies for any reason, a major natural disaster (meteor strike, super volcano, etc), and a number of other low probability reasons. All of these events are possible, but they are unpredictable, and the probabilities are low that they will happen in the next few years or even decades.

[CR 2016 Update: The recent recession calls are mostly based on exogenous events: the problems in China and in commodity based economies (especially oil based).  There will be some spillover to the US such as fewer exports (and an impact on oil producing regions in the US), but unless there is a related financial crisis, I think the spillover will be insufficient to cause a recession in the US.]

2) Significant policy error. This might involve premature or too rapid fiscal or monetary tightening (like the US in 1937 or eurozone in 2012).  Two examples: not reaching a fiscal agreement and going off the "fiscal cliff" probably would have led to a recession, and Congress refusing to "pay the bills" would have been a policy error that would have taken the economy into recession.  Both are off the table now, but there remains some risk of future policy errors. 

Note: Usually the optimal path for reducing the deficit means avoiding a recession since a recession pushes up the deficit as revenues decline and automatic spending (unemployment insurance, etc) increases.  So usually one of the goals for fiscal policymakers is to avoid taking the economy into recession. Too much austerity too quickly is self defeating.

[CR 2017 Update: Austerity was a mistake (obvious at the time).  And it is possible that we will see serious policy mistakes from the new administration (a complete wildcard).  And it is possible the Fed could tighten too quickly. ]

[CR April 2018 Update: We are seeing policy mistakes from the Trump administration on taxes, immigrations, and trade. See: When the Story Change, Be Alert. I'm watching for the impact of these policy mistakes.]

1) Most of the post-WWII recessions were caused by the Fed tightening monetary policy to slow inflation. I think this is the most likely cause of the next recession. Usually, when inflation starts to become a concern, the Fed tries to engineer a "soft landing", and frequently the result is a recession. Since inflation is not an immediate concern, the Fed will probably stay accommodative for a few more years.

So right now I expect further growth for the next few years (all the austerity in 2013 concerns me, especially over the next couple of quarters as people adjust to higher payroll taxes, but I think we will avoid contraction). [CR 2015 Update: We avoided contraction in 2013!] I think the most likely cause of the next recession will be Fed tightening to combat inflation sometime in the future - and residential investment (housing starts, new home sales) will probably turn down well in advance of the recession. In other words, I expect the next recession to be a more normal economic downturn - and I don't expect a recession for a few years.

[CR April 2018 Update: This was written in 2013 - and my prediction for no "recession for a few years" was correct.  This still seems correct today, so no recession in the immediate future (not in 2018). ]

by Calculated Risk on 4/12/2018 08:33:00 AM

The DOL reported:

In the week ending April 7, the advance figure for seasonally adjusted initial claims was 233,000, a decrease of 9,000 from the previous week's unrevised level of 242,000. The 4-week moving average was 230,000, an increase of 1,750 from the previous week's unrevised average of 228,250.

Claims taking procedures in Puerto Rico and in the Virgin Islands have still not returned to normal.
emphasis added

The previous week was unrevised.

The following graph shows the 4-week moving average of weekly claims since 1971.

Click on graph for larger image.


The dashed line on the graph is the current 4-week average. The four-week average of weekly unemployment claims increased to 230,000.

This was slightly higher than the consensus forecast. The low level of claims suggest relatively few layoffs.

by Calculated Risk on 4/11/2018 06:15:00 PM

From Frank Nothaft at CoreLogic: Tax Reform: Effect on Home Prices; No material price effect so far, though it is still early after reform

The Tax Cuts and Jobs Act enacted in December was the largest change to the U.S. tax code in more than three decades. Tax reform has touched every person and industry. Let’s examine how it affects housing decisions made by families.

Overall, tax reform has lowered personal income taxes, not necessarily for each taxpayer but in the aggregate. An increase in after-tax income, at the margin, generally increases the amount of shelter consumed and the likelihood of being a homeowner. Economists refer to this as the ‘income effect’. Thus, the increase in after-tax income should be a net plus for housing demand and homeownership, holding all else constant.

But all else is not constant. Tax reform also lowered the maximum loan size for interest deductibility on new first-mortgage debt to $750,000, eliminated deductibility for some second liens, and capped the annual deduction for state and local income and property taxes at $10,000. Further, the hike in the standard deduction will substantially reduce the number of tax filers who itemize, and lower marginal tax rates reduce the value of deductions for those who do itemize. By raising the after-tax cost of homeownership, tax reform is expected, at the margin, to lower the amount of shelter consumed by owner-occupants and tilt tenure choice toward renting rather than owning. Economists refer to this as the ‘price effect’ because the relative cost of owning versus renting has changed.

Whether the ‘income’ or the ’price’ effect is stronger will determine whether demand for shelter and homeownership rates rise, fall, or are largely left unchanged.

CR note: My view is there are certain segments of the housing market that might see a negative impact. I discussed this in Question #10 for 2018: Will the New Tax Law impact Home Sales, Inventory, and Price Growth in Certain States?

Thursday:
• At 8:30 AM ET, The initial weekly unemployment claims report will be released.  The consensus is for 230 thousand initial claims, down from 242 thousand the previous week.

by Calculated Risk on 4/11/2018 02:05:00 PM

Still on pace for 3 or 4 rate hikes in 2018.  Some excerpts:

From the Fed: Minutes of the Federal Open Market Committee, March 20-21, 2018:

With regard to the medium-term outlook for monetary policy, all participants saw some further firming of the stance of monetary policy as likely to be warranted. Almost all participants agreed that it remained appropriate to follow a gradual approach to raising the target range for the federal funds rate. Several participants commented that this gradual approach was most likely to be conducive to maintaining strong labor market conditions and returning inflation to 2 percent on a sustained basis without resulting in conditions that would eventually require an abrupt policy tightening. A number of participants indicated that the stronger outlook for economic activity, along with their increased confidence that inflation would return to 2 percent over the medium term, implied that the appropriate path for the federal funds rate over the next few years would likely be slightly steeper than they had previously expected. Participants agreed that the longer-run normal federal funds rate was likely lower than in the past, in part because of secular forces that had put downward pressure on real interest rates. Several participants expressed the judgment that it would likely become appropriate at some point for the Committee to set the federal funds rate above its longer-run normal value for a time. Some participants suggested that, at some point, it might become necessary to revise statement language to acknowledge that, in pursuit of the Committee's statutory mandate and consistent with the median of participants' policy rate projections in the SEP, monetary policy eventually would likely gradually move from an accommodative stance to being a neutral or restraining factor for economic activity. However, participants expressed a range of views on the amount of policy tightening that would likely be required over the medium term to achieve the Committee's goals. Participants agreed that the actual path of the federal funds rate would depend on the economic outlook as informed by incoming data.
emphasis added

by Calculated Risk on 4/11/2018 11:36:00 AM

The Cleveland Fed released the median CPI and the trimmed-mean CPI this morning:

ccording to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.3% (3.0% annualized rate) in March. The 16% trimmed-mean Consumer Price Index rose 0.1% (1.7% annualized rate) during the month. The median CPI and 16% trimmed-mean CPI are measures of core inflation calculated by the Federal Reserve Bank of Cleveland based on data released in the Bureau of Labor Statistics' (BLS) monthly CPI report.

Earlier today, the BLS reported that the seasonally adjusted CPI for all urban consumers fell 0.1% (-0.8% annualized rate) in March. The CPI less food and energy rose 0.2% (2.1% annualized rate) on a seasonally adjusted basis.

Note: The Cleveland Fed released the median CPI details for March here.  Motor fuel was down 45% annualized in March.

Click on graph for larger image.

This graph shows the year-over-year change for these four key measures of inflation. On a year-over-year basis, the median CPI rose 2.5%, the trimmed-mean CPI rose 1.9%, and the CPI less food and energy rose 2.1%. Core PCE is for February and increased 1.5% year-over-year.

On a monthly basis, median CPI was at 3.0% annualized, trimmed-mean CPI was at 1.7% annualized, and core CPI was at 2.1% annualized.

Using these measures, inflation increased in March.  Overall, these measures are close to the Fed's 2% target.

by Calculated Risk on 4/11/2018 08:32:00 AM

From the BLS:

The Consumer Price Index for All Urban Consumers (CPI-U) decreased 0.1 percent in March on a seasonally adjusted basis after rising 0.2 percent in February, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index rose 2.4 percent before seasonal adjustment.

A decline in the gasoline index more than outweighed increases in the indexes for shelter, medical care, and food to result in the slight seasonally adjusted decline in the all items index. The energy index fell sharply due mainly to the 4.9-percent decrease in the gasoline index. The index for food rose 0.1 percent over the month, with the indexes for food at home and food away from home both increasing

The index for all items less food and energy increased 0.2 percent in March, the same increase as in February. ... The all items index rose 2.4 percent for the 12 months ending March, the largest 12-month increase since the period ending March 2017 and higher than the 1.6-percent average annual rate over the past 10 years. The index for all items less food and energy rose 2.1 percent, its largest 12-month increase since the period ending February 2017.
emphasis added

I'll post a graph later today after the Cleveland Fed releases the median and trimmed-mean CPI. This was close to the consensus forecast of no change for CPI, and a 0.2% increase in core CPI.

by Calculated Risk on 4/11/2018 07:00:00 AM

From the MBA: Mortgage Applications Decrease in Latest MBA Weekly Survey

Mortgage applications decreased 1.9 percent from one week earlier, according to data from the Mortgage Bankers Association’s (MBA) Weekly Mortgage Applications Survey for the week ending April 6, 2018.

... The Refinance Index decreased 2 percent from the previous week. The seasonally adjusted Purchase Index decreased 2 percent from one week earlier. The unadjusted Purchase Index decreased 1 percent compared with the previous week and was 0.5 percent lower than the same week one year ago. ...

The average contract interest rate for 30-year fixed-rate mortgages with conforming loan balances ($453,100 or less) decreased to 4.66 percent from 4.69 percent, with points increasing to 0.46 from 0.43 (including the origination fee) for 80 percent loan-to-value ratio (LTV) loans.
emphasis added

Click on graph for larger image.


The first graph shows the refinance index since 1990.

Refinance activity will not pick up significantly unless mortgage rates fall 50 bps or more from the recent level.



The second graph shows the MBA mortgage purchase index

According to the MBA, purchase activity is DOWN 0.5% year-over-year.

by Calculated Risk on 4/10/2018 07:54:00 PM

From Matthew Graham at Mortgage News Daily: Mortgage Rates Still Sideways Ahead of Key Inflation Data

Mortgage rates were roughly unchanged again today. Some lenders were slightly higher in rate, but not enough to affect the average. Underlying bond markets (which dictate rates) have been eerily calm so far this week, ostensibly with an eye on tomorrow morning's big inflation report. [30YR FIXED - 4.5%]
emphasis added

Wednesday:
• At 7:00 AM ET, The Mortgage Bankers Association (MBA) will release the results for the mortgage purchase applications index.

• At 8:30 AM, The Consumer Price Index for March from the BLS. The consensus is for no change in CPI, and a 0.2% increase in core CPI.

• At 2:00 PM, FOMC Minutes for the Meeting of March 20-21, 2018

by Calculated Risk on 4/10/2018 04:52:00 PM

From the Port of Long Beach: Port of Long Beach Breaks 1st Quarter Record

The Port of Long Beach has completed its best-ever first quarter, with marine terminals handling almost 1.9 million twenty-foot equivalent units (TEUs) January through March. The quick start is 19.4 percent more than the first quarter of 2017, the Port’s busiest year ever.

The previous first quarter record was set in 2007.

March throughput reached 575,258 TEUs, an increase of 13.8 percent compared to the same month last year.

“Our March cargo jumped despite the shipping slowdown during the Lunar New Year holiday in China,” said Port of Long Beach Executive Director Mario Cordero.

CR Notes: Exports were up sharply in March. I'll have more on the LA area port traffic once Los Angeles releases their March statistics.

by Calculated Risk on 4/10/2018 01:35:00 PM

At the end of last year, I posted Ten Economic Questions for 2018. I followed up with a brief post on each question. The goal was to provide an overview of what I expected in 2018 (I don't have a crystal ball, but I think it helps to outline what I think will happen - and understand - and change my mind, when the outlook is wrong).

By request, here is a quick Q1 review (it is very early in the year). I've linked to my posts from the beginning of the year, with a brief excerpt and a few comments:

10) Question #10 for 2018: Will the New Tax Law impact Home Sales, Inventory, and Price Growth in Certain States?

My sense is the low end of the housing market will be fine. The Mortgage Interest Deduction (MID) will be capped at interest on a mortgage up to $750,000 instead of $1,000,000, so the lower priced markets will not be hit by the reduction in the MID. There might be some additional taxes for these buyers due to the limits on SALT and property taxes, but this should be minor.

I also expect the high end of the market to be fine. The high end is already doing well even with the MID capped at $1 million. For these buyers, the bigger impact will be the SALT and property tax limitations, but there will be offsets for these buyers due to the lower rates - and these buyers will likely benefit from the corporate tax cuts.  Many of these buyers will also benefit from the changes to the Alternative Minimum Tax (AMT).

It is the upper-mid-range in the certain markets that will probably slow.  This might be in the $750,000 to $1.5 million price range.  These potential buyers probably don't benefit from the AMT or corporate changes, but they will likely be hit by the SALT and property tax limits. 

It is still too early to determine the impact of the new tax law on housing.

9) Question #9 for 2018: Will housing inventory increase or decrease in 2018?

I was wrong on inventory last year (and the previous year), but right now my guess is active inventory will increase in 2018 (inventory will decline seasonally in December and January, but I expect to see inventory up again year-over-year in December 2018).   My reasons for expecting more inventory are 1) inventory is historically low (lowest for November since 2000), 2) and the recent changes to the tax law.

According to the February NAR report on existing home sales, inventory was down 8.1% year-over-year in February, and the months-of-supply was at 3.4 months. This was the smallest year-over-year decline since last August, and some local inventory data suggests inventory might increase this year.

8) Question #8 for 2018: What will happen with house prices in 2018?

Inventories will probably remain low in 2018, although I expect inventories to increase on a year-over-year basis by December of 2018.  Low inventories, and a decent economy suggests further price increases in 2018.

Perhaps higher mortgage rates will slow price appreciation.  If we look back at the "taper tantrum" in 2013, price appreciation slowed somewhat over the next year - but that was from a high level.  In June 2013, the Case-Shiller National index was up 9.3% year-over-year.  By June 2014, the index was up 6.3% year-over-year.

If inventory increases year-over-year as I expect by December 2018, it seems likely that price appreciation will slow to the low-to-mid single digits.

If is very early, but the CoreLogic data released last week showed prices up 6.7% year-over-year in February.  The CoreLogic year-over-year increase is about the same as last year, and there is no evidence of price increases slowing yet.

7) Question #7 for 2018: How much will Residential Investment increase?

Most analysts are looking for starts to increase to around 1.25 to 1.3 million in 2018, and for new home sales of around 650 thousand.

I also think there will be further growth in 2018. My guess is starts will increase to just over 1.25 million in 2018 and new home sales will be just over 650 thousand.

Through February, starts were up about 2% year-over-year compared to the same period in 2017, and on pace for about 1.28 million this year.  New home sales were also up about 2% year-over-year and on pace for about 620 thousand in 2018.

6) Question #6 for 2018: How much will wages increase in 2018?

As the labor market continues to tighten, we should see more wage pressure as companies have to compete for employees. I expect to see some further increases in both the Average hourly earning from the CES, and in the Atlanta Fed Wage Tracker.  Perhaps nominal wages will increase close to 3% in 2018 according to the CES.

Through March 2018, nominal hourly wages were up 2.7% year-over-year. This is about the same as last year, and it is too early to tell if wages will increase at a faster rate in 2017.

5) Question #5 for 2018: Will the Fed raise rates in 2018, and if so, by how much?

My current guess is the Fed will hike three times in 2018.

As an aside, many new Fed Chairs have faced a crisis early in their term.   A few examples, Paul Volcker took office in August 1979, and inflation hit almost 12% (up from 7.9% the year before), and the economy went into recession as Volcker raised rates.   Alan Greenspan took office in August 1987, and the stock market crashed almost 34% within a couple months of Greenspan taking office (including over 20% in one day!).  And Ben Bernanke took office in February 2006, just as house prices peaked - and he was challenged by the housing bust, great recession and financial crisis.

Hopefully Jerome Powell will see smoother sailing.

The Fed has already hiked once in 2018, and they are still forecasting three hikes this year.

4) Question #4 for 2018: Will the core inflation rate rise in 2018? Will too much inflation be a concern in 2018?

The Fed is projecting core PCE inflation will increase to 1.7% to 1.9% by Q4 2018.  However there are risks for higher inflation with the labor market near full employment, and new tax law providing some fiscal stimulus.

I do think there are structural reasons for low inflation, but currently I think PCE core inflation (year-over-year) will increase in 2018 and be closer to 2% by Q4 2018 (up from 1.4%), but too much inflation will still not be a serious concern in 2018.

It is early, but inflation has moved up closer to the Fed's target.

3) Question #3 for 2018: What will the unemployment rate be in December 2018?

Depending on the estimate for the participation rate and job growth (next question), it appears the unemployment rate will decline into the high 3's by December 2018 from the current 4.1%.   My guess is based on the participation rate declining about 0.2 percentage points in 2018, and for decent job growth in 2018, but less than in 2017.

The unemployment rate was at 4.1% in March.

2) Question #2 for 2018: Will job creation slow further in 2018?

So my forecast is for gains of around 150,000 to 167,000 payroll jobs per month in 2018 (about 1.8 million to 2.0 million year-over-year) .  Lower than in 2017, but another solid year for employment gains given current demographics.

Through March 2018, the economy has added 605,000 thousand jobs, or 202,000 per month. This is somewhat above my forecast, but I still expect employment gains to slow this year.

1) Question #1 for 2018: How much will the economy grow in 2018?

It is possible that there will be a pickup in growth in 2018 due to a combination of factors.

The new tax policy should boost the economy a little in 2018, and there will probably be some further economic boost from oil sector investment in 2018 since oil prices have increased recently.  Also the housing recovery is ongoing, however auto sales are mostly moving sideways.

And demographics are improving (the prime working age population is growing about 0.5% per year, compared to declining a few years ago).

All these factors combined will probably push GDP growth into the mid-to-high 2% range in 2018.  And a 3% handle is possible if there is some pickup in productivity.

Once again, GDP will be sluggish in Q1 - the Atlanta Fed GDPNow is forecasting 2.0% in Q1 - and it is way too early to tell if there will be any pickup in GDP growth this year.

It is early, but currently it looks like 2018 is unfolding as expected - although, based on Q1 data, employment gains might be slightly higher than I originally expected.