Who’s Most Impacted By Inflation? All Of Us.

Things are looking grim. Today’s inflation report came in hotter than expected much to the disappointment of the bond and equity markets. Equity markets are getting slammed, while Treasury yields are rising. Today’s report puts the Fed substantially behind the curve on inflation. A dramatic action might be necessary to provide even the smallest form of relief. Until today, you wouldn’t hear this from most commentators on CNBC – that one cannot take a 75 or 100 bp event totally off the table. This blog has advocated for rate hikes for quite some time and believed a 75 bp hike a few months ago would have been appropriate. Signaling from the Fed has been very poor, as well as, from the Treasury. Letting inflation run hot was a terrible mistake. Like most Americans, inflation has been evident in our daily purchases for months. Let’s hope the Fed makes the right decisions soon, to avoid recession. It is becoming an increasingly difficult environment to navigate. In my opinion, inflation, and not the equity or housing market, remains priority number one. So, there will certainly be more pain ahead.

Although consumer and business confidence remains weak, a combination of stock market volatility, the slowing housing market, and 120 oil may be doing some of the work for the Fed. Anecdotally, this week I happened to be out to dinner more than usual, and I noticed that restaurants are less busy. The gas attendant at the local gas station said fewer people are filling up. Bank management is less eager to lend. All these things suggest the economy may already be in recession. With unemployment at 3.60%, it is hard to envision a major recession taking place. Nonetheless, I am reading about many layoffs, especially in higher-paying jobs such as technology.

The Housing Market & Our National Reality Check

There is not much good news to talk about. Rising rates and a cooling economy will lead to lower house prices. Supply-constrained markets such as Southern California probably won’t see a big price dip unless the bond market and equity market do not steady, but home prices will come down as demand wanes. This is a positive note for those waiting to buy, but not so much for those who recently bought.

The one benefit of this reset is that wages, the cost of living, and people’s expectations of what a normal rate of return looks like, have gotten a major reality check. There is no such thing as a free lunch, unlimited debt financing, or continued parabolic returns on investments. You can’t spend your way out of inflation. There is now a return to the mean and that is good news for the next generation. Easy money is never easy. Success is earned and above-average returns require skill and thought.

Equity Market Volatility Pushes Bond Yields Lower

It was another week of agonizing volatility in both the bond and equity markets. Big box retailers reported tighter margins due to high inflation. Economists continue to move year-end targets down. One wonders if all of this negativity signifies an end to selling. S&P touched correction territory before trading higher into the close on Friday. Long-dated bond yields fell below 2.800%. Trading remains volatile but orderly. As we have mentioned previously, don’t expect the Fed to step in and backstop the equity or housing market anytime soon. Inflation is the Fed’s primary concern and they will tolerate a falling equity market and a higher unemployment rate to subdue inflation. Case in point, the WSJ reported that subprime credit delinquencies are rising from historically low levels as the increased cost of food and energy preys on consumers. Even the wealthy appear to be cutting back on spending. The soaring costs across all corners of the economy are weighing on people’s confidence and willingness to spend.

Impact On Real Estate & The Global Economy

Limited housing inventory will keep home prices from falling too dramatically. However, given the wealth destruction incurred in both the bond and equity market, it is difficult to see real estate being impervious to recent events. The dramatic rise in mortgage rates over the last 60 days will push some buyers to the sidelines.

With China shut down, and the world economy slowing, perhaps long-term interest rates will continue their recent descent. This would be helpful to growth stocks in addition to homebuyers, consumers, and businesses. We hope that long rates don’t move too low, as an inverted yield curve would be worrisome. Housing demand remains healthy, which bodes well overall for the economy. Should this change, we would become very nervous over a deep recession.

Next week is important for the markets as the Fed’s favorite inflation gauge, the PCE, is released. The markets will respond favorably should inflation appear to be topping out. However, should the reading come in hotter than expected, be prepared for a sobering market reaction.