Since the early part of 2023, the three “E’s” of employment, economy, and earnings have all been rising, superseding concerns about the two “I’s” of inflation and interest rates. But one concerning and underreported feature of the current environment is the vicious cycle composed of the housing industry, interest and mortgage rates, rents, and Federal Reserve policy, writes John Eade, president of Argus Research.

Activity in the housing economy is well below year-earlier and two-year-earlier levels due to high prices and high mortgage rates. To get the sector moving again, interest and mortgage rates have to come down. To get rates down, the Fed has to be confident inflation is declining and it can cut the federal funds rate.

But inflation is stalled. And the biggest culprit is shelter, one-third of consumer inflation. Rents are high and rising because few people can afford to buy homes at current price/mortgage levels, and are competing for the insufficient supply of rental units. Both supply-demand imbalance and higher costs are compelling landlords to keep raising rents at three times the underlying level of all other inflation.

That keeps overall inflation too elevated for the Fed to cut. That, in turn, keeps market rates of interest too high for mortgage rates to come down...which keeps new and existing home sales activity at current very depressed levels...which contributes to higher rental demand amid insufficient rental unit availability...which keeps shelter inflation so high that it prevents overall inflation from coming down...which keeps the Fed on the sidelines.

We are not sure how this vicious cycle can be broken. But a frustrated Fed is now contemplating two or fewer rate cuts in the second half of 2024, after modeling three or more cuts just a few months ago. As long as inflation remains above the Fed’s comfort zone, we expect volatility to continue in the stock market.

Subscribe to Argus Research here…