The economic signals you need to watch right now

The Federal Reserve's most reliable indicator of inflation just confirmed what most every American is feeling these days: things are just plain expensive! The core personal consumption expenditures index (core PCE) measures the prices paid by consumers for goods and services while excluding the more volatile components of food and energy prices. The Fed watches this figure closely to identify underlying inflation trends. The latest core PCE data shows a 5.4% year-over-year increase—the highest annual jump since April 1983. If you add in food and energy, PCE hit an annualized increase of 6.4%—that's its fastest pace since January 1982.

This report came out two weeks after the Fed instituted a quarter-point hike in the federal funds rate. It is now likely that at the Fed's next meeting, the Federal Open Market Committee will institute a half-point increase in the federal funds rate in an effort to slow inflation. 

Further strengthening the Fed's case for more robust interest rate hikes was another solid jobs report from the Bureau of Labor Statistics. Nonfarm payrolls added 431,000 jobs for the month with the unemployment rate moving to 3.6%. It's slightly lower than economists' predictions but still another month of showing the labor market tightening. 

A more concerning economic occurrence that is typically an early indicator of a recession happened in the last week of March. The yield curve on the 10 and 2-year Treasury notes inverted. This is an indication that investors are not optimistic about economic health in the long-term. 

There has been a yield curve inversion before every recession since 1955, but not all yield curve inversions have been followed by a recession. Right now, volatility spurred by inflation and Russia's war on Ukraine have investors worried that the Fed's monetary tightening process will not go smoothly. 

There was also an inversion of the 5- and 30-year Treasury yields just before the March jobs report was released. This was the second time in a week that these note yields inverted. The first one, on Monday March 28, was the first time these yields inverted since 2006.

WHAT'S HAPPENING IN HOUSING

All the factors we just discussed—inflation, war on Ukraine, rising federal funds rate and the yield curve inversion—have an indirect effect on housing. When it becomes more expensive for financial institutions to borrow money (higher federal funds rate) they will increase their rates for lending out money (mortgages). 

It's all reflected week over week in Freddie Mac's 30-year fixed-rate mortgage average. The latest numbers show an average of 4.67%. That has certainly slowed down the homebuying process, but hasn't stifled it completely. Freddie Mac's economists note, "​​Purchase demand has weakened modestly but has continued to outpace expectations. This is largely due to unmet demand from first-time homebuyers as well as a select few who had been waiting for rates to hit a cyclical low."

As we continue to move toward a 5% average rate, it's likely we could see that pressure offset the burden that is rising home prices. The latest S&P CoreLogic Case-Shiller national home price index shows that home prices rose at a rate of 19.2% in January. Rising home prices coupled with rising rates make it much less affordable to purchase a home. 

Although not the best of solutions, it's possible that this combination of rising interest rates and high home prices could slow the competition and create some breathing room as the market starts to normalize. It is hard to think about rates nearing 5% as normal, but it's extremely important to keep in mind just how much of an anomaly the last two years truly were.