A Temperature Check in Three Reports
Plus: a poem
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I had several topics I wanted to touch on this week, so instead of the usual single article with a little more meat to it, this week I have three appetizers, all of which serve as general updates on the state of things in the economy and banking world.
Inflation Stays Stubborn
This week’s Consumer Price Index report offered a Valentines Surprise in the wrong direction. The monthly change in inflation for the month of January was +0.3%, a tick up from the December rate of +0.2% and clocking in on a year-over-year basis at +3.1%, which is still stubbornly above the Fed’s stated goal of +2.0%. The most notable increases were in shelter (rent + homes) and food prices. Keep in mind that data for shelter inflation typically lags; the numbers hitting the CPI are often based on home transactions with Purchase & Sale dates at least several months prior, for example. But shelter does represent a large chunk of the CPI so when that number is high, so too is the overall inflation statistic.
What are the implications? With the labor market and consumer spending as strong as ever and inflation not quite touching the 2.0%-3.0% range, the timing of the Fed’s anticipatory rate cuts will now be delayed. Market prognosticators had at one point been targeting the Fed’s upcoming March meeting as the first time we might see an interest rate cut, but now there is only a 10.5% chance of that happening according to the CME FedWatch Tool. This tool, which aggregates market predictions, now predicts only a 35.3% chance that rates will be cut during the May meeting; previously it had been considered a near certainty that rates would be dropping by May. There is now a 71.3% chance rates will drop by June and an 89.1% chance rates will drop by July, at least according to this one source.
Lenders Are Tight
Additional recent data in the form of the Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) provides insights into the minds of senior lenders, loan committees, management teams, and the board rooms of banks across the country. Many of the people in those rooms are grumpy these days. Among the highlights from the January SLOOS, released earlier this month:
Not a single senior loan officer among the 60 surveyed reported their banks’ standards were easing for most types of lending, especially commercial, which is in fact getting tighter.
Among those surveyed whose banks were tightening their lending standards, a full 50% said that concerns about deterioration in their bank’s liquidity position was either “somewhat” or “very” important. Additionally, 78.6% said that concerns about a less favorable or more uncertain economic outlook were “somewhat” or “very” important.
Lending for construction loans has become particularly tight, with nearly half of those surveyed saying their banks have tightened standards for this type of loan. The percentage holds roughly the same when the question is asked specifically of multifamily residential properties and non-residential commercial properties.
On a more positive note, lending standards for home loans have not tightened quite as much as for commercial loans, although loan officers are seeing generally weaker demand for both commercial and residential loans as interest rates remain quite high. I know from where I sit, many deals just do not work on the commercial side when the interest rate starts with an 8 whereas two or three years ago it might have started with a 3, 4, or 5. At a certain point it is just a question of math.
What does all of this mean? Banks are tight. Lenders and their loan committees have concerns about the intermediate-term future of the economy as well as their own liquidity positions. And lending standards continue to tighten, which means it is harder to get a loan. That in and of itself will lead to a tightening of the economy at some point even if the impacts lag and are difficult to quantify. If both businesses and individuals are less able to get a loan, it means fewer purchases will take place, not as many business will expand, and there will be less hiring and an overall dampening of economic activity. This is, of course, the Fed’s goal in raising interest rates as much as they did: to rein in inflation by cooling down the economy. What we are seeing now is what has been meant to happen.
Multifamily Rental Construction Drops Off
Higher interest rates that make the cost of borrowing more expensive combined with banks that are tightening means that less borrowing activity is taking place, as noted above. This is already playing out and is evident in certain key statistics. As shown in the chart below, new multiunit (defined as 5+ units) construction plummeted from December to January. The seasonally adjusted rate of 314,000 units newly started is almost half as much as it was for much of 2022-2023 and is as low as pre-pandemic rates of construction:
What does it mean? The focus of some of what I wrote above was that banks are pulling back, but so too are builders and developers. It is unfortunate that at a moment in time when new housing is so sorely needed, the financing of new construction has become so challenging. Interest rates are a big part of this, but so too is the high cost of materials and labor. Yet as Fed Chairman Jerome Powell has said recently, however, the Fed’s job is not housing policy, it’s inflation and employment, so there is little hope that the Fed will adjust simply for the sake of housing.
Summing it All Up
These three reports tell a story of an economy that feels much like a ship turning in a channel. Inflation remains elevated, interest rates remain high, banks are feeling anxious, and construction is dampening. The natural question becomes whether we are looking at an economic drawback or an actual crash. I will have more thoughts on this in the weeks ahead, but for now at least with regard to the housing market I still believe much of what I wrote a couple of years ago comparing the then-current 2021 with 2007 in believing that we are not headed for a a housing crash. I still do not believe we are looking at a collapse in the housing market. That said, perils exist particularly in non-residential office space, most notably in large cities. More on that to come.
Ben Sprague lives and works in Bangor, Maine as a Senior V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com.
Weekly Round-Up
Here are a few more things that caught my eye this week.
Fed Chairman Jerome Powell said on 60 Minutes recently that he expects some small and mid-size banks to have such significant problems in their commercial real estate portfolios that they will need to merge or be taken over by other larger banks. He calls the problem, “manageable,” however. Read more here or watch the interview here.
Lance Lambert of Residential Club shared a statistic this week on X that 27 million fewer households qualify for home loans right now due to high interest rates, saying, “This rate shock is also an eligibility shock.”
Per the most recent Gallup poll, 50% of Americans say they were better off a year ago. 60% of Americans believe they will be better off this time next year. The percentage of people who said they were better off a year ago is the highest percentage since 2009. This as unemployment is near all-time lows and wages are rising faster than inflation. In short, the vibes are off in a big way.
A Poem
This past week at my weekly Rotary Club meeting, Retired Pastor Dr. Jim Haddix read the following poem by Robert Hayden. Hayden grew up in poverty raised by foster parents in Detroit. He would publish numerous collections of poetry, and was the first African American to be appointed as Consultant in Poetry to the Library of Congress. I wanted to share it because it is a good poem, but also in honor of Black History Month. It reads:
Sundays too my father got up early
and put his clothes on in the blueblack cold,
then with cracked hands that ached
from labor in the weekday weather made
banked fires blaze. No one ever thanked him.
I’d wake and hear the cold splintering, breaking.
When the rooms were warm, he’d call,
and slowly I would rise and dress,
fearing the chronic angers of that house,
Speaking indifferently to him,
who had driven out the cold
and polished my good shoes as well.
What did I know, what did I know
of love’s austere and lonely offices?
You can read more about Robert Hayden here.
One Good Long Read
From The New Yorker, an article by David Owen on what happens to items that get returned. Apparently some retailers have as much as 40% of their sales get returned. “Americans are the world’s leading refund seekers,” he says. This article features numerous interesting anecdotes and bits of trivia, including a story of Sam Walton, the founder of Walmart, working at JC Penney’s, and how sometimes JC Penney’s would accept items returned from Sears just because they wanted their customers to be happy. You can read the full article here.
Have a great week everybody!