Navigating the Impact of Rate Hikes and Economic Downturns

The market is currently experiencing a shift in expectations, with the potential for three more rate hikes by December. This is quite different from just four weeks ago when the market was anticipating rate cuts in 2023. Additionally, recent data from Case-Shiller indicates a 0.2% decline in US home prices compared to last year, marking the first year-over-year decline since 2012. On the other hand, inflation reports show signs of improvement. Despite these factors, the market is still facing more rate hikes.

It's important to recognize that the market is inherently unpredictable, and change is a constant factor. To navigate this market successfully, adaptability is key. It's crucial to anticipate changes, volatility, and uncertainty.

Federal Reserve Chairman Jerome Powell has been clear about the Fed's intention to continue its strategy of curbing inflation. This strategy involves raising rates and reducing the money supply. During his semiannual report to Congress, Chairman Powell emphasized the Fed's focus on reining in inflation and stated that rates will continue to rise until they are confident that inflation is being controlled. Powell acknowledged that raising rates could potentially slow down economic growth, but he believes that the long-term benefits of reducing inflation outweigh the short-term costs. As he put it, "There's no painless way to 2% inflation."

Given the news of upcoming rate hikes, it is possible that there will be changes in demand. Currently, seasonally adjusted mortgage applications for home purchases have increased by 1.5% compared to the previous week. However, they remain 32% lower than the same time last year. Mortgage applications are generally considered a reliable indicator of demand in the housing market.

Recession signals?

The recently released Leading Economic Index (LEI) by the Conference Board, which is a composite of economic indicators that can indicate peaks and troughs in the business cycle, showed a 0.7% decline in May. This marks the fourteenth consecutive month of contraction, indicating weaker economic activity ahead, according to Justyna Zabinska-La Monica, Senior Manager of Business Cycle Indicators. Notably, the last time the index experienced a fourteen-month decline was in 2007, preceding the onset of the great recession.

Furthermore, there are indications of economic conditions slowing down overseas. The Global Purchasing Managers' Index (PMI) revealed that Japan is currently in a state of contraction, while Australia, the Eurozone, and the United Kingdom have experienced a slowdown and are hovering just above the contraction territory. Given the interconnectedness of global economies and their reliance on each other for trade, recessions often occur in a synchronized manner. This synchronization is attributed to the loss of demand in one country having a ripple effect on economic activity in other regions.

Typically, around 50% of global economies are in a recession at any given time. However, certain circumstances, such as the COVID pandemic, can lead to greater levels of synchronicity among economies. It is crucial to monitor this ongoing situation in the coming months as it holds significance for global economic conditions.

It is worth considering whether a 2% inflation rate is achievable without a recession, even if it is mild. The connection between economic growth and inflation suggests that sustained economic expansion is necessary to support higher inflation rates.

The Burden of $32 Trillion National Debt

As of June 2, the United States suspended the debt ceiling until 2025, allowing the government to borrow funds without immediate limitations. Since then, the national debt has risen by $701 billion, surpassing the milestone of $32 trillion in total debt. This growing debt poses long-term implications for the economy and raises concerns about fiscal sustainability, including increased interest payments and potential limitations on budgetary decisions. Monitoring and addressing the national debt are crucial for maintaining economic stability and ensuring the well-being of future generations.

What could go wrong?

In 1980, the US National Debt accounted for 31% of the GDP. By 2010, it had risen to 87%, and presently it stands at 121%. This escalating trend raises concerns about the potential consequences when the government allocates more funds towards debt payments than programs aimed at benefiting its citizens. There are no indications of a slowdown in government spending.

In the year 2023 alone, the US is projected to spend more on interest costs than on vital programs like Medicaid and Income Security Programs such as Social Security. The mounting debt restricts available resources for investing in crucial areas like education and technology, limiting future prospects.

The increasing national debt coupled with high inflation could lead to prolonged periods of higher interest rates. This combination could have adverse effects on economic opportunities for Americans, as rising debt discourages business investments and hampers overall economic growth.

While some argue that as long as inflation remains within an acceptable range, concerns about the growing national debt are unwarranted, it is essential to recognize that debt requires income to be sustained. Imagine if your debt payments amounted to 121% of your net income—you would be at risk of default unless you tapped into your savings or liquidated other investments to mitigate the risk. Similarly, the government faces the same challenge. However, it is certain that the US will not default, and the national debt may triple over the next decade. This raises the question of how the government plans to increase its income or revenue.

Income taxes play a significant role in generating revenue for the government. Should wages increase instead of tax rates? This poses a significant dilemma. As the Federal Reserve tightens monetary policy, wage growth becomes less likely. This could have negative implications for the job market, potentially leading to a higher unemployment rate while still falling short of the desired 2% inflation target. It is crucial to consider that rising wages contribute to inflationary pressures, while higher tax rates can diminish purchasing power. Resolving this complex issue is challenging but worth contemplating as one plans for the future.

Promoting Equitable Homeownership for All

Although the report indicates an overall increase in homeowner wealth, there are significant disparities among homeowners of different income levels:

- Low-income households, defined as those earning less than 80% of the area median income, experienced a net worth gain of $98,900 solely from home appreciation over the past decade.

- Middle-income households, earning between 80% and 200% of the area median income, saw their wealth grow by $122,100 during the same period.

- High-income households, earning more than 200% of the area median income, had a wealth gain of $150,800.

Furthermore, the report highlights notable discrepancies in homeownership rates among different ethnicities:

- The homeownership rate for Black individuals stood at 44.9% by the end of 2022.

- The homeownership rate for White individuals reached 74.5%.

- The homeownership rate for Asian Americans amounted to 61.9%.

- The homeownership rate for Hispanic Americans was at 48.5%.

Over the past decade, homeowners across all racial groups analyzed in the study experienced an average increase of over $100,000 in home value. Here is the breakdown:

- Asian homeowners gained $239,430 in value.

- Hispanic homeowners gained $162,450 in value.

- White homeowners gained $138,430 in value.

- Black homeowners gained $115,430 in value.

Building wealth is crucial not only for individual financial stability but also for the overall economy. Home equity and retirement accounts comprise 60% of a household's net worth, as reported by the U.S. Census Bureau and the National Association of Realtors (NAR).

SOURCE: MONEY.COM