Good morning. The market “vibe shift” we have written about in the past few letters continued yesterday. Treasury yields fell at both the short and the long end of the curve, with real yields, rather than inflation expectations, powering most of the declines. Rate cut expectations for this year continued to rise; a full 25-basis point rate cut has now been added in less than two weeks. Big Tech stocks, especially Tesla, had a hard day. More dreary consumer sentiment data appeared as well, this time from the Conference Board, which also reported rising inflation expectations. Can anything put an end to the bad news? Well, a blowout earnings report from Nvidia might do the trick, and as it happens, the AI chip leader releases results this afternoon. And if Nvidia’s numbers disappoint? Best not to think about it. Email us: [email protected] and [email protected].
Is the vibe shift for real? Place your bets
Markets are a bit alarmed by indications that growth is slowing and inflation is not. Are we seeing a downward inflection point — or is the recent data just a blip? The numbers have been consistently poor lately, but on the other hand, the Trump policies that were expected to drive a strong economy and support the market — tax cuts and substantive deregulation — have not happened yet.
At a moment like this, making predictions is useful. It forces mental discipline. So let’s attempt a forecast for the end of this year, for two crucial variables: inflation and unemployment. Will they be higher or lower than they are now? That is: will the economy cool, as recent data suggests it will, bringing unemployment up? Will tariffs and immigration enforcement rekindle inflation? Longtime Unhedged readers will remember that we like to think in terms of matrices. Here goes:
We very much want to hear from readers about what you think about the probabilities of squares A through D (as ever: [email protected]). Remember they have to sum to 100!
For the record, Rob thinks that inflation is more likely than not (60 per cent/40 per cent) stuck at or above its current level, and that the labour market is more likely than not going to stay pretty tight. This renders the following probabilities: 24 per cent A, 36 per cent B, 16 per cent C and 24 per cent D. That is, high inflation is still a bigger risk than rising unemployment, but the worst of all worlds — stagflation — is a real possibility.
Housing
Bearish commentators have pointed to a softening US housing market as a key contributor to the negative vibe shift, and a threat to future growth. Fair enough: existing home sales fell 30 per cent from December to January, new housing construction (“starts”) fell 10 per cent, new construction permits granted were flat and completions of new houses — that is, additions to inventory — ticked up:
While none of this is welcome news, the state of the housing market is not much worse today than in October, when we last wrote about it. High mortgage rates continue to stifle demand. Inventories are too high. And prices are not falling enough to bring in buyers:
What has changed is the outlook. Though mortgage rates today are around where they were in October, they jumped in between, further unsettling the market:
Though mortgage rates have backed off a bit recently, homebuilder stocks have been falling steadily for five months:
There is more to the decline in the stocks than mortgage rates. Typically, homebuilders see a pick-up in sales in the spring, but that might not be coming. From Rick Palacios at John Burns Consulting:
Homebuilders are going into this season with too much standing inventory. The hope was sales would accelerate as sales kicked off . . . But homebuilders are stepping off the gas a bit, as they realise spring will not be as strong as [originally] anticipated.
There are other fears for homebuilders on the horizon. According to Troy Ludtka at SMBC Nikko Securities America, “a lot of homebuilders rely on undocumented labour”; President Donald Trump’s immigration policies could make completing new homes harder and more expensive. And tariffs, especially on lumber from Canada, could raise input costs, either further suppressing demand or forcing homebuilders to accept smaller margins on projects they’ve already started.
But as Palacios noted to Unhedged, this was the outlook “flattening, not falling off a cliff.” Homebuilders were already pulling back, and many have beefed up their supply chains since the pandemic to get around some of the tariffs. And a somewhat bigger pullback will not be catastrophic for the US economy. Yes, residential investment is a swing factor for economic growth, and slow residential investment has weighed on GDP growth in recent quarters. But while the news from the housing market is not good, it looks mostly priced in.
(Reiter)
One good read
[Crosses legs]
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