The outlook for the U.S. economy brightened over the summer due to declining energy prices, steady consumer spending, and solid payroll growth. There was also a belief in the markets that the Federal Reserve would potentially ease up on the pace and magnitude of their interest rate hikes as inflation data showed signs of cooling. The Consumer Price Index (CPI) report in July confirmed inflation had decelerated slightly as the annual rate came in at 8.5%, still close to a multi-decade high but lower than the four-decade peak of 9.1% hit in June. While we may have seen the peak in inflation, it was our perspective that investors were becoming overly optimistic in their assumptions regarding the Federal Reserve, and the summer rally was a bear market rally from oversold conditions.
During the much-anticipated Jackson Hole Economic Symposium on August 26th, Fed Chairman Jerome Powell rattled markets by saying, “Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy…While the lower inflation readings for July are welcome, a single month’s improvement falls far short of what the committee will need to see before we are confident that inflation is moving down”. He went on to say, “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”
These hawkish comments sent equity and bond markets lower to finish the month of August as investors grappled with concerns of restrictive monetary policy that could cause a slowdown in economic growth. Treasury yields rallied on the expectation of further rate hikes (see chart right). Many investors expected a slow down in the pace of Fed rate hikes, but the data would need to show a meaningful deceleration in the pace of inflation for that to be a consideration. We anticipate the next rate hike to be an additional .75 basis points on the Federal Funds Rate, which put the target rate at 3.25%.
As you also see from the chart (right), longer-dated bond yields have followed the path of the 2-yr Treasury note, which has recently broken above its previous high. This breakout signals that bond yields could continue to rise, which would further raise concerns of a potential slowdown in economic growth. As noted above, if U.S. inflation were to decelerate in the coming months, the Fed may yet have room to pause its current rate hiking cycle and assess how its policy has impacted the economy. This would temporarily calm government bond yields, and if prices of oil and other commodity were to stabilize or decline from current levels, this would be supportive of economic growth.
Review of US Housing Market
U.S. housing demand has dropped sharply in recent months as new and existing home sales have declined (chart right). There has also been decline in builder-reported traffic of potential buyers (chart following page). With this, the housing sector has turned from being one of the strongest sectors of the economy to one of the weakest, which is a direct and intentional consequence of the Fed’s rapid pivot away from accommodative monetary policy this year. Although mortgage rates remain high, the recent pullback in demand has not yet translated into lower home prices.
Home prices are likely holding up because the housing inventory level is relatively low. The smaller number of buyers are still bidding on a constrained pool of available homes. As a result, homes are not sitting unsold on the market for very long. In addition, existing homeowners have locked-in mortgage rates well below current levels. This will discourage them from listing homes for sale (and buying new, or other existing properties) unless necessary. It should be noted that existing home inventories, which were previously growing solidly on a year-over-year basis, seem to have taken a step back in August. This suggests that those who would have been potential home sellers in a better housing market may be starting to hold back from listing homes.
U.S. household and financial sector balance sheets are healthy, and there is no reason to anticipate a wave of foreclosures and distressed sales that might tank housing values, as was the case in 2007-2009. The labor market remains tight, and previous sizable housing downturns have coincided with meaningful increases in unemployment, which is so far not evident.
Generational Wealth Transfer
Start the discussion – Once you start thinking about the future and how you want your wealth to live on, it’s tempting to dive right in and start putting money strategies into place immediately. However, problems can arise when it comes time to implement these strategies without a thorough family discussion about this wealth transfer. Talking about money with your family can be uncomfortable, but it is a necessary step to achieving your financial goals. It can also help create a more open and trusting relationship within your family, allowing you to pass down more than just monetary wealth.
Involving your future heirs in setting a multigenerational wealth plan can greatly improve your chances of following through with that plan. By establishing open communication from the beginning, children and grandchildren are allowed to express their opinions and money values. It also provides a way to teach financial management skills to children and grandchildren by involving them in family philanthropy and investment. If all family members are involved in the decision-making process, it can help avoid later arguments over who is given what. Finally, if the reasons behind financial decisions are made clear before your death, heirs are more likely to stick to the plan after your death.
Understanding “Money Values” – Understand where family members stand on money values. More than just dollars and cents, getting an idea of what wealth will mean to your family members is important. Even with the most carefully thought-out plans, without a sense of family cohesiveness and shared values, money can be lost due to arguments among beneficiaries or careless spending by descendants. Making sure your financial principles are in line with those of your future heirs, beneficiaries and trustees can help to establish the direction of your wealth transfer and prevent future conflicts.
Guide the way – The next generation will almost certainly look to you for financial guidance, consciously or subconsciously. This realization allows you to be more realistic as you help them plan for the future and presents opportunities for you to encourage them to work with trusted fiduciaries and professionals that put their interests first, as we do at Pacific Coast. We hope to continue to serve as a trusted resource for you and your family.