Weekly Economic Update 10-27-23: Home Sales; Durable Goods; Personal Income; PCE Inflation; and 3Q GDP

The views and opinions expressed in this post are solely those of the author and do not necessarily reflect the views of the Georgia Institute of Technology or the Georgia Board of Regents.

Last week we changed the name of this weekly post from “Weekly Economic Digest” to “Weekly Economic Update.” It was actually an accident, but rather than change it back, we are sticking with “update.” It has a better ring to it, and frankly, that is what it is…an “update” on the economic data of the week. So, Weekly Economic Update it is, and there was a lot of data released this week to “update” you on. Most of the attention this week was given to the advanced estimate of third quarter GDP. But, before we get to that, let’s discuss the all other data we got this week, starting with housing.

New Home Sales

Originally, the Case-Shiller home price index was due to be released this week, but for some reason, the release was delayed until next week. However, we did get data on mortgage applications from the Mortgage Bankers Association and new home sales from the Department of Commerce. Mortgage applications dropped 2.2% last week to their lowest level since 1995. Not surprising since mortgage rates hit 8% for the first time in 23 years. Rising rates are giving borrowers pause, and in turn, this is putting pressure on mortgage lenders who are clearly struggling in this environment. For example, this week, Homestar Financial Corporation, headquartered in Gainesville, GA ceased operations. In an internal memo, the company blamed “mortgage volatility driven by the macro economy” and said “these unforeseen events have made mortgage lending unsustainable for anyone except the most deep-pocketed lenders.” Frankly, I’m not sure how “unforeseen” this was…anyone observing Federal fiscal policy since 2020 and the Fed’s policy response should have seen this coming a mile away.

Given the trend in both mortgage rates and mortgage applications, it was a surprise when the Department of Commerce reported that new home sales surged 12.3% in September to an annual rate of 759,000 – their highest level since early 2022. (This number refers to how many homes would be built over an entire year if builders continued at the same pace every month.) This was far faster than the 680,000 pace that economists were expecting. Basically, what buyers there are simply can not find inventory among existing homes so they are turning to home builders.

Even so, supply of new homes dropped to 6.9 months, the lowest level since early 2022. The lack of home building, combined with low inventory of existing homes (due to the fact that people simply are not going to let go of their existing mortgage) is providing support for high prices. As such, despite raising rates, the Fed is unable to deal with the “affordability crisis” and IF they cut rates next year, pent up demand will just drive prices higher exacerbating the housing affordability issue.

Finally, pending home sales (transactions where the contract has been signed for the sale of an existing home, but the sale has not yet closed) rebounded 1.1% in September but remain near record lows. Again, high mortgage rates and low inventory continue to hurt the real-estate sector.

Durable Goods

Orders for durable goods exploded in September rising 4.7% month-over-month and 7.8% from one year ago. Virtually all the growth was in the transportation sector. In fact, non-defense aircraft orders were up 92.5% from August. Without this explosive transportation spending, orders were up only 0.5% for the month, and were up only 1.6% from a year ago. Given that inflation is running at more than 3.5%, in real terms, non-transportation durable goods orders are actually down from 2022.

Personal Income and Spending

For the third time in four months, real personal consumption grew faster than real disposable personal income. Obviously, it is unsustainable (not to mention fiscally irresponsible) for spending to grow faster than income. As a result, the personal savings rate dropped to 3.4%

It is interesting to note that wage growth for workers in the private sector is trending down, while wage growth for government employees is trending up. In fact, in September government sector wage growth was 7.1%…the highest rate of public-sector wage growth since 2000.

PCE Inflation

The Personal Consumption Expenditures (PCE) Index (the Fed’s preferred measure of inflation) rose more than expected in September at an annual rate of 3.4%…well above the Fed’s 2% target. Core PCE was down slightly from August, but is still running at 3.7% annual rate. The cost of services also came down slightly but is still running at 4.7% on an annual basis. This is significant as services represent about 2/3 of all personal consumption so that 4.7% is felt by households on a daily basis.

Not only do consumers feel those high prices…they expect them to go even higher! Earlier this month we reported on the preliminary University of Michigan Consumer Sentiment Survey where consumers were expecting higher prices (3.8%) over the next 12 months. Well, now at the end of the month, the final data spiked to 4.2%! Consumers are feeling the effects of inflation and they are expecting more to come in the next year.

Third Quarter GDP (Advance Estimate)

And now the big news…..according to the Bureau of Economic Analysis (BEA), the economy grew at a 4.9% annual rate in the third quarter – the fastest pace since 2014 (excluding post pandemic quarters) and more than twice as fast as it grew in the second quarter!

This number is very hard to believe. First of all, according to the BEA, for the first time since the first quarter of 2021 (10 quarters ago), residential fixed investment was a positive contributor to the economy. Keep in mind that during the quarter, housing starts were at their lowest level since 2019 (excluding the pandemic) and home sales have been anemic. Someone will need to explain to me how residential fixed investment was a positive contributor to GDP. Second, according to the BEA, personal consumption contributed 2.7% of the growth by growing at a 4% annual rate. That is the highest rate since the fourth quarter of 2021. This while real retail sales were negative for all three months of the quarter. That would mean that consumers went absolutely crazy purchasing services in the third quarter. (And going to see Taylor Swift concerts and Barbie movies may very well qualify as crazy….) In fact, of the 2.7% contribution to GDP, services represented 1.62% or about 60% of the growth in personal consumption. But that still leaves 40% (or 1.08% of the growth rate) due to the consumption of goods…again, while every indication we have from the retail sales data is that goods consumption was down in real terms.

Those of us from the South have heard the old saying…”I may have been born at night, but it wasn’t last night!” I have been doing macro analysis for more than 30 years, and these numbers simply are not consistent with everything else we were told about the economy in the third quarter. Further, they are certainly NOT what the Federal Reserve wants to see! The “experts” are still thinking the Fed will hold rates constant at their meeting next week. Even if they do hold, numbers like this make interest rate cuts in early 2024 much less likely.

Remember, this is the “advance” estimate and is based on limited data. Like has been the case so often recently, I fully expect these numbers will go down as more data comes in. Otherwise, someone has a lot of explaining to do. In fact, let me offer an explanation, and one I think captures the reality of what is happening. Perhaps the 4.9% growth doesn’t reflect real economic activity…rather, it is evidence that inflation is actually running much hotter than reported. In this GDP report, the “GDP deflator” (the adjustment factor to remove inflation from the numbers) is only 3.5%. Even if we use the highly-flawed measure of CPI, core CPI is running 4.1%! As previously noted above, the PCE for services is running 4.7%! So, if inflation is actually running hotter than the GDP deflator suggests, then the “real” growth reported in the GDP number is actually the result of higher prices, not real economic activity. And that is a much more believable scenario than the existence of a “strong consumer” and growth in residential investment.