What Can Go Wrong: Recession Probability

The Fed’s Minutes from July 31st to August 1st mostly includes discussion about risk. This is logical because the economy is growing quickly and inflation is modest. When you have a situation which meets the criteria for a Goldilocks economy which has allowed stocks to reach record highs, you need to worry about what can go wrong. In this article, we’ll go into detail about how the risks the Fed mentioned are playing out. To be clear, there is a 96% chance of a rate hike in September and a 62.8% chance rates are 50 basis points higher by December. These percentages didn’t change much because of the Fed Minutes.

Weakness In The Housing Sector

It’s obvious that weakness in the housing sector is a problem for the economy. We showed in a previous article that the buying conditions are at the lowest point since 2008 because of rising rates, depleted inventories, and expensive prices. In the Minutes, the Fed stated, “Starts for new single-family homes were little changed, on average, in May and June, but starts of multifamily units declined on net. The issuance of building permits for both types of housing was lower in the second quarter than in the first quarter, which suggested that starts might move lower in coming months. Sales of existing homes edged down in May and June, while sales of new homes moved up on balance.”

These points are all accurate. Let’s look at the July existing home sales report from Wednesday, which the Fed didn’t have access to a few weeks ago. Existing home sales were 5.340 million on a seasonally adjusted annual run rate basis which missed estimates for 5.42 million and the lowest estimate of 5.39 million. This is the 4thstraight decline in existing homes sales as they were down 0.7% month over month and 1.5% year over year. Existing homes sales are at the lowest rate in 2.5 years as rising rates and a 0.5% decline in supply aren’t a good combination.

Interestingly, the decline is mainly coming from the low end of the market just like the how the bottom third of the income distribution catalyzed the weakness in the August consumer sentiment report. As you can see from the table below, single-family houses costing less than $100,000 were the only ones which saw weakness in July. The higher the price, the greater the sales growth as the stock market is helping those with assets grow their net worth and buy higher priced houses.