Fed raises rates, GDP growth is strong, new home activity robust

What's happened recently?

The past couple of weeks have been relatively calm in markets. Economic news has been stronger than expected, broadening the positive performance of the market beyond a handful of tech stocks. 

Here are a few things standing out in the news:

• U.S. economic growth beats expectations
• Federal Reserve raises rates
• New homes starts and permits showing resilience

Why is this important?

Economic data over the past few months consistently surpassed expectations, changing the market’s narrative from strong recessionary fears to the possibility of a soft landing – despite a historic rise in interest rates. 

• U.S. GDP growth accelerated stronger than expected to 2.4%, marking the fourth straight quarter of positive growth. Households are still the lynchpin, showing robust spending in the quarter (contributing 1.1% to GDP growth, in line with the trend since late 2021). Business spending, however, was a strong contributor (nonresidential private investment contributed almost 1% to GDP growth, which is the strongest showing since mid-2021), showing surprising resilience in the face of tighter credit conditions.
• The Fed believes the economy is still running too hot and raised rates this week, demonstrating their focus on lowering inflation. While inflation has moderated, labor markets remain in disequilibrium, with demand outstripping supply. The Fed, therefore, remains “data dependent” and is looking for repeated declines in core inflation data and is keeping the door open for another rate hike later this year.
• The housing sector has been one of the hardest hit by rising rates over the past 18 months – existing home sales are down 32% since the start of 2022. High mortgage rates have discouraged homeowners from selling their homes, creating very low inventory in houses. While the sector as a whole is still under pressure, there have been bright spots. For instance, demand for new homes remains strong (new home sales are up 28% since July 2022) and there are signs of increased supply as new home construction and permit issuance have picked up (over the past three months housing starts and permits are up over 6% and 15%, respectively). This could potentially help drive economic growth and provides a more positive backdrop for a much-beleaguered part of the economy.

What's our take?

We believe the economy is still in a fragile state and the effects of rising rates remain uncertain. However, the remarkable resilience of the U.S. consumer and moderating inflation increases the (still low) odds of a soft-landing, which may allow markets to continue their upward march since the beginning of the year. Corporate earnings still bear watching over the coming weeks as they will add more color to the overall economic picture – the few companies that have reported so far have been positive.

We are still cautious about the effects of interest rates on business and consumers. The consumer has been a key driver of the economy and has beaten expectations quarter after quarter. Consumers entered this period of rising rates in decent shape as they had a decent amount of savings post-pandemic and many had taken advantage of an extended period of low interest rates (e.g. locking in 30-year mortgages at 3%). Despite rates rising significantly, the cost of servicing consumer debt (e.g. mortgages, car loans, credit cards, etc.) remains quite low (see chart below). We are watching for any indications that consumers and businesses are having more difficulty servicing their debts, which may likely raise alarms for the broader market.

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