Weekend Talking Points - 'Off the Fence'

REMINDER! Only one WEEK remains before the August 17 implementation date for the NAR settlement. Got your new forms and your scripts ready?

Jobs report shocked the market. Last Friday’s BLS jobs report showed that the US economy added 114,000 jobs in July, far below expectations of +175,000. More worryingly, the unemployment rate jumped from 4.1% to 4.3%.

TP: Recall that the BLS report came out two days AFTER the latest Fed meeting. By the way, most Fed members didn’t expect the UR to hit 4.3% before 2025.

The Sahm “Rule” has been triggered. Whenever the unemployment rate rises more than half a percent within a year, it’s an (almost) sure sign that we will soon be in (or already are in) a recession. [More on this later.]

Stock markets got crushed. Bad news is bad news again. [More on this later.] The NASDAQ fell 6% in a day, and global markets followed. The Japanese yen had a massive move higher as “carry trades” unwound and the TOPIX (Japan’s main index) plunged 21%!

Treasury yields plunged. The yield on the 10-year US Treasury dropped from 4.0% to 3.8%, with the futures market now putting very high odds on a 50 basis point (0.5%) rate cut on September 18, and a further 50 basis points in cuts before year-end.

TP: The yield on the 10Y UST was 4.5% in early July. This has been a dramatic move lower.

And mortgage rates followed. Average 30-year mortgage rates fell to a low of 6.34% on August 5 (the Monday after the BLS jobs report). While this is still much higher than the mortgage rates most homeowners currently have, this should still be positive for transaction volumes.

TP: Here come the refis! Over the last two years, around 6 million existing homes were purchased with a mortgage, often at rates considerably higher than currently available. Lower mortgage rates also bring would-be sellers closer to the psychological breakeven where the benefits of moving house outweigh the negatives of taking on a higher rate mortgage.

Now four states with inventory above pre-pandemic levels. According to Realtor.com data, Idaho and Tennessee joined Florida and Texas with July 2024 active inventory (homes for sale) above July 2019 levels. Washington state is very close, and CO/UT/WY are ~5% below. While inventory levels don’t correlate directly with home price moves, there’s a clear relationship. [More on this later.]

Rent growth remains modest. Rents increased just 0.2% month-over-month in July and flat to negative moves look likely for the remainder of the year. [Apartment List]

TP: Meanwhile, the growth in the “shelter” price index in CPI is still running at +5%, massively overstating inflation.

Home price growth continues to cool. National home prices rose 0.3% month-over-month in June (+4.7% year-over-year), but 9 states experienced falling prices MoM. [CoreLogic]

Everything Changed with the July BLS Jobs Report

In every tightening cycle, there comes a point where bad news = good news suddenly shifts to bad news = bad news. I think the July BLS jobs report provided the latest inflection point. Let me explain.

When the Fed Funds Rate is high, everybody is hoping for “bad” economic news (slower consumer spending, rising unemployment) because it encourages the Fed to begin cutting rates. Lower rates tend to lift asset prices. Lower rates improve mortgage affordability. Bad news is good news.

But the Fed usually keeps rates too high for too long. A recession arrives and the Fed rushes to lower rates. Everybody knows this. So when the “bad” news looks bad enough, it makes people worry about an impending recession. And a recession means big job losses, a plunge in consumer spending and industrial activity, declining company earnings, a big fall in stock prices, and a negative wealth effect. Bad news is bad news.

Federal Funds Rate (Gray bars indicate official recession) — note how a Fed tightening cycle precedes most recessions.

What is the Sahm “Rule”?

Since the BLS jobs report, there has been an explosion of news articles talking about the likelihood of a recession. Many of them mention the Sahm “Rule” being triggered, and how this indicates that a recession is coming soon (or is already here). So what exactly is the Sahm “Rule”, and is it really so infallible?

The Sahm “Rule” is named after Claudia Sahm, a respected economist who was on President Obama’s Council of Economic Advisors and had worked at the Federal Reserve Board of Governors. She noticed that a rapid change in the unemployment rate (“UR”) was a better predictor of a recession than the level of the UR.

In other words, you could have a low UR and still get a recession. In fact, most recessions begin with a low UR! The FRED graph below shows the UR over the last 75 years. The gray bars indicate an “official” NBER recession. See what I mean?

Sahm “Rule” Calculation
3-Month Moving Average UR minus the Minimum UR of the Past 12 Months

Or put simply, how quickly has the UR moved up from its cycle low?

For July 2024, you take the average of the past 3 months’ UR (4.1%) and you subtract the low UR of the last 12 months (3.7%).

4.1% — 3.7% = 0.4%

If that difference is equal to or greater than 0.5%, the Sahm “Rule” says that you are in, or shortly will be in, a recession. We triggered the Sahm “Rule” in June 2024.

Below, I’ve graphed the Sahm “Rule” calculation over the past 75 years. Pay attention to when the calculation is low, but then moves up to 0.5. That’s when the Sahm “Rule” is triggered. You’ll notice that in almost every incidence, the calculation then spikes higher. That’s when a recession causes the UR to really blow out.

Over the last 75 years, there have been 15 Sahm “Rule” triggers, and the recession call was correct 12 times (80%). Not bad at all! There were two false positives (although one was really just an early call for a recession that did end up coming). And there is one trigger that we can’t be sure about yet (we’re living it now).

Wondering why I’ve so diligently placed quotes around “Rule”? First, because it isn’t a rule, it’s a rule of thumb. A very useful rule of thumb, to be sure, but in the social science of economics, nothing is certain. Second, because every time you have a recession, you will absolutely have some point where the calculation moves above 0.5. Looking back at the data, the Sahm “Rule” is more often a coincident, rather than leading, indicator of a recession.

TP: By the way, Claudia Sahm is still very much alive. Amusingly, she has conducted recent interviews where she said that we should ignore her “rule”.

What’s Happening with Listing Inventory?

The latest active inventory data from Realtor.com provides further evidence of the giant gap between inventory levels in the Northeast and Midwest regions (still very tight), and the South and Mountain regions (near or above pre-pandemic levels). We now have four states with July 2024 active inventory higher than July 2019 (pre-pandemic):

Change in Active Inventory (July 2024 vs. July 2019)
Texas: +6.5%
Idaho: +5.5%
Florida: +4.7%
Tennessee: +2.0%
(and Washington state is basically flat to July 2019)

“But that’s only 4 states!” you might be thinking. Yes, but Florida and Texas represent 29% of nationwide active inventory. That tells you that the inventory situation in the rest of the county is very different. In fact, there were 14 states with July 2024 active inventory that was still less than half of what it was in July 2019!

Change in Active Inventory (July 2024 vs. July 2019)
Connecticut:-74.8%
New Jersey: -67.1%
Illinois: -65.5%
Vermont: -63.1%

While inventory levels don’t correlate directly to price movements, it is no coincidence that the biggest price declines are happening in certain cities in the South while the biggest price increases are happening in certain cities in the Northeast and Midwest. The scatterplot below makes the relationship fairly clear.

Change in the Median Listing Price by State (July 2024 vs. July 2023)
Vermont: +27.3%
New Jersey: +19.3%
Wisconsin: +14.3%
Florida: -5.3%
Texas: -3.1%
Tennessee: -3.0%
Idaho: -2.0%

Mortgage Market

Friday’s weaker than expected BLS jobs report sent bond prices skyrocketing (and yields plunging). The yield on the 10-year US treasury went as low as 3.69%, and average 30-year mortgage rates went as low as 6.34%.

Since then, bonds have given back a lot of their gains, but the trading environment has definitely changed. The Sahm “Rule” has been triggered, the probability of a recession has risen, and multiple rate cuts are back on the agenda.

Here are the current odds on Fed rate cuts at upcoming FOMC meetings below. Keep in mind that the US Presidential election is on November 5.

• Sept 18: 100% (same as last week); the probability of a 50 basis points cut rose from 30% to 56%.
• Nov 7: 100% (same as last week); 67% probability that rates will be 75–100 basis points lower than current
• Dec 18: 100% (same as last week); 75% probability that rates will be 100–150 basis points lower than current.

They Said It

“Policy adjustments will be necessary in the coming quarter. How much that needs to be done and when it needs to take place, I think that’s going to depend a lot on the incoming information. But from my mind, we’ve now confirmed that the labor market is slowing and it’s extremely important that we not let it slow so much that it turns itself into a downturn.” — Mary Daly, San Francisco Federal Reserve Bank President

“The Fed was late moving away from the restrictive monetary policy stance when early signs of a softening economy were visible. Soft manufacturing survey data, falls in construction activity, and damaging financing costs for small businesses clearly hint at a cooling economy and further cooling in inflation. The Fed may make a deeper cut of 50 basis points in September.” — Lawrence Yun, NAR’s Chief Economist

‍