CPI Report – Is There a Risk of a Housing Recession?

The figures relating to the Consumer Price Index were issued by the Bureau of Labor late last week (CPI). The most prevalent type of inflation measurement showed an increase of 8.6 percent higher in May 2022 compared to May 2021. This constitutes the greatest year-over-year inflation level in more than 40 years, an increase from the figure of 8.3 percent that was recorded in April.

Sadly, another high inflation statistic should not come as much of a surprise to anybody. As we are all aware, the rate of inflation has reached an all-time high. It is something that we regularly experience at the cash machines of the grocery shops and the filling stations.

However, although we have all learned to anticipate inflation, the particulars of this latest study were very alarming. It means that prices are going up even more quickly than before.

As you can see in the figure that is available above this one, the average monthly rise in the CPI was around 0.7 percent throughout the most recent few months. However, in March, it jumped to 1.2 percent, mostly due to the effect of the Russian invasion of Ukraine and the consequent surprise to the energy market. This was the primary cause of the rise.

The first signs of improvement emerged in April. A monthly gain of 0.3 percent was the strongest print we had seen in months and gave a glimmer of hope that inflation, although still climbing, was starting to approximate its peak. Although costs were still rising, the monthly rise of 0.3 percent was the best print we had seen in months.

May’s rain ruined that parade. The number of professionals predicted that inflation in May would increase by around 0.7 percent; however, it actually increased by 1 percent, which is a significant step backwards.

According to the data, at least one or two categories have decreased month-over-month pricing in most of the previous few months. Almost all product categories reported price increases in May, the first time this has happened since November 2021.

The Consumer Price Index (CPI) data was discouraging, and inflation seems to continue for some time. Therefore, the issue that must be answered is how and when inflation will be controlled.

In order to provide an appropriate response to this inquiry, it is necessary first to provide a concise explanation of what inflation is and how we got to the current situation.

What Does Inflation Mean?

The term “inflation” refers to the process through which the purchasing power of the U.S. dollar decreases over time. To put it another way, prices go up, and to get the same products or services, you will need to pay a higher price.

Inflation is one of the most damaging factors affecting an economy. It puts a lot of pressure on the finances of regular Americans and makes it challenging for individuals, particularly those on the lowest end of the socioeconomic spectrum, to make ends meet. Additionally, it is detrimental to the United States in terms of its standing in international commerce and can contribute to developing other socioeconomic problems. When inflation rises as it has recently, it’s important to keep it under control.

It is important to remember that some degree of inflation is seen as a positive thing since it helps boost the economy. People are encouraged to spend their money now instead of wait because they are conscious that, in normal circumstances, prices will continue to increase somewhat every year. This provides them with the motivation to spend their money. Why, for instance, would you wait to purchase a vehicle if the exact same automobile is going to be two percent more costly the next year?

What are the Roots of the Problem of Rising Prices?

The encouragement to spend helps assure that firms will have the opportunity to keep growing. This is the reason why the Federal Reserve aims to maintain an annual inflation rate of 2 percent.

A wide range of complicated circumstances causes inflation. However, similar to most other economic ideas, its origins can be traced back to supply and demand. Inflation occurs whenever there is a situation in which demand is higher than supply, which is the condition of our economy at the moment.

There are primarily two drivers behind the current increase in demand.

First, people are willing to engage in activities and part with their money once again! After being unable to participate in certain activities for some time, individuals develop a desire to discover life’s pleasures, such as travelling, going out to restaurants, shopping for automobiles, and more. It is almost as if the latent demand that has been building up over the last two years is now being released into the economy.

Second, in recent years, an incredible quantity of new money has been poured into the economy. This phenomenon is referred to as a rise in “monetary supply,” and it indicates that more money is circulating throughout the economy. More money in the economy encourages consumers to spend more on products and services.

If you only had $1,000 to your credit, the most you would be prepared to spend for a sandwich would probably be ten dollars. Just think about it. However, if you unexpectedly had $1,200 to your credit due to more money being pushed into the economy, maybe your willingness to spend for that same sandwich would increase to $12. (still 1 percent of your net worth).

There is a lot of general demand since COVID-19 limitations have been loosened up. There has been a sudden and significant rise in the amount of money available. These are the kinds of circumstances that set the stage for inflation.

On the other hand, the circumstances for inflation are favorable on the supply side. In a normal situation, when there is a healthy sales spike in a marketplace, the providers will boost their output to satisfy that demand. Because of this, pricing can remain largely unchanged, and vendors can sell a greater quantity of goods and bring in higher total revenue.

However, because of problems with the global supply chain that we are now experiencing, suppliers cannot increase their output to satisfy customer demand. Instead, increasing costs is the only way to bring demand down to a more manageable level.

At this very moment, we are experiencing the inflationary effects of the perfect storm, which consists of very high demand combined with limited supply.

What Is the Next Step?

Many analysts and observers, including myself, anticipated that inflation would reach its maximum level (not halt or deflate; rather, it would just slow down) somewhere in the middle of 2022, mostly due to supply restrictions being moderate. The accepted thinking was that once economies resumed normal operations, the supply chain would also resume normal processes. While there is a good chance that demand would be strong, producers would be able to boost output to satisfy it, which would result in a decline in inflation.

However, two significant events in the world of politics shattered such hopes. First, Russia invaded Ukraine, which imposed severe sanctions on Russia. A supply chain that was already suffering is put under further stress due to the exclusion of Russia (and Ukraine in many aspects) from the global economy. Second, China has maintained the enforcement of lockdowns to restrict COVID, which has resulted in delays in the manufacture and production of commodities inside China.

It seems that the May inflation report compensates for this recently discovered information. Many people anticipated that demand would continue to be strong, and they were right; nevertheless, the supply-side respite that was hoped for is not materializing. Because of this, inflation is now at a greater level than it has been in the last forty years.

The Federal Reserve enters the picture at this point. Raising interest rates is the key weapon in the Fed’s arsenal against inflation, which it uses by raising those rates. Because fewer people are willing to take out loans and spend money when interest rates are higher, there is less money in circulation. As was previously said, demand also decreases when there is a decrease in the available supply of money. In other words, the Fed is restricting monetary supply to reduce demand from companies and consumers.

In most cases, this strategy is successful; nonetheless, it is time-consuming and may have other unfavorable effects on the economy, including a recession.

When interest rates are higher, consumers are less likely to take out loans to finance significant purchases such as a new vehicle or house. This results in a decrease in income across those sectors, leading to reduced expenditure and job cuts.

When it comes to enterprises, they are also less likely to take out loans, which leads to them buying less equipment, hiring fewer people, expanding into fewer areas, and often being forced to let staff go without pay. In theory, this will cause the economy to slow down to the point where demand will decrease and become more in line with supply, achieving equilibrium. 

That brings us to the current situation. The Federal Reserve is actively boosting interest rates to fight the unacceptably high level of inflation.

My Opinions

Even though no one can predict the future, here are some of my current thoughts. Keep in mind that this is simply my opinion based on the information that is presently available:

Many different aspects of the economy will be severely affected due to the Federal Reserve’s decision to increase interest rates. This week we have already witnessed the share market reach bear market territory (down more than 20 percent off its peak). Since this article was written, Bitcoin has lost more than 60 percent of its value. Even though there are over 10 million unfilled employment positions in the United States, I expect the labor market to get more competitive over the next few months, which will increase layoffs. Because of the confluence of all these elements, I predict that a recession will most certainly begin within the next few months.

There are a lot of various kinds of recessions. At this point, it is unclear whether or not it will happen, how long it will persist, or how severe it may get. That, in my opinion, is contingent on whether or not inflation can be brought under control.

Concerning the cost of housing, which I’m sure is something everyone in this room is curious to learn more about, I believe there is increasing market risk. I have been saying for the last several months that I anticipate prices would reduce considerably and might turn flat or moderately negative (on a national scale) in the future year. This is something I feel will continue to be the case. Despite this, I believe that by the end of 2023, national home prices will be within a range of plus or minus ten percent of where they are right now. On a regional scale, I anticipate that some markets will see significant decreases (declines of more than 10 percent), while others may continue to show growth.

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