KEY DATA: Confidence: +0.3 point; Present Situation: -8.8 points; Expectations: +6.4 points/ FHFA (Month): +0.6%; Over-Year: 5.2%/ Case-Shiller (Month): +0.5%; Over-Year: +3.8%
IN A NUTSHELL: “Consumers remain confident, but continued declines in the equity markets are likely to test their resolve.”
WHAT IT MEANS: The markets are beginning to face reality but for most of the last couple of months, investors have generally paid little attention to the potential impact on the U.S. and world economies. Thus, with equity prices generally rising and the labor market solid, it was hardly a surprise that the Conference Board’s Consumer Confidence Index rose in February. Yes, the gain was less than expected, but the level remains high. That said, there was a real warning in the data: The Present Situation index fell sharply. That offset a jump in expectations. The likelihood is that U.S. growth will moderate over the next few months and if the stock market doesn’t bounce back quickly, then both components could decline. Consumers are going to spend decently, but their broad shoulders are likely to start slumping.
Home prices rose sharply in December and it looks like the decelerating price pattern is turning around. Both the Case-Shiller and Federal Housing Finance Agency’s national price indices were up solidly at the end of last year. The big difference was in the gain for the year. The FHFA number was significantly higher than the Case-Shiller rise. If we average the two, the increase was moderate and sustainable, which is what you would expect in an economy that is expanding moderately. But there is a concern. Price gains have been decelerating for at least two years and that is in a market where there is an immense supply shortage. Prices in more areas should be rising faster. If the economy slows more than expected, we could see price increases fade significantly. MARKETS AND FED POLICY IMPLICATIONS: Well, I have been asking for weeks when or even if investors would wake and smell the antiseptic and it looks like that finally happened yesterday. The idea that “what happens in China stays in China” was always nonsensical and to hear traders say they didn’t think the epidemic could be this bad makes me think that they have to get out of the trading pits once in a while – or maybe even once. Markets are efficient; but they don’t have to be rational. In this case, some fear should have been built in but it wasn’t. Thus, this is likely a correction, adjusting prices to better reflect the uncertainty that has been there all along. But when it comes to Jerome Powell, corrections are not viewed as price resetting. They represent a challenge to growth that has to be met head on with all the power of the Fed. Dumb? Yes, but that is how he acted at the end of 2018. The huge equity price gains were not supported by economic and earnings fundamentals and when the inevitable correction occurred, he turned into Chicken Little. As the Fed members have been noting recently, there is not a lot of ammunition left and the Fed is going to have to resort to non-interest rate strategies if a major slowdown occurs. The worry I have is that Mr. Powell will panic again and use up the last of his key weapon, lower interest rates. Once you hit about one percent, the reaction function to further rate cuts largely disappears. If you have to go to one, you are probably headed to zero and you only go to zero when there is a crisis. So, why would businesses or individuals increase their borrowing or investing when rates get that low? Go me, but the Fed Chair seems to think they will. We have a long way to go before we get even close to correction territory and it is hardly clear that will even happen. But given the Fed Chair’s history, I don’t have a lot of confidence the Fed will react in a manner that not only provides short-term stability but also allows for longer-term policy flexibility.