Twenty-three percent of all mortgages outstanding have an interest rate below 3%, 38% are between 3% and 4%, and only 9% of all mortgages outstanding were originated with an interest rate above 6%, see the first chart.

The bottom line is that homeowners across America do not have any incentive to move and get a new mortgage with mortgage rates currently at 7.25%.

This is a key reason why the supply in the housing market continues to be so low, see the second chart.

The chart below shows the average probability of not being able to make minimum debt payments over the next three months for people earning more than $100,000. The bottom line is that higher-income households are starting to worry about their finances.

The Fed has raised the Fed funds rate to 5%, and the lagged effects of Fed hikes will continue to drag down growth over the coming 12 months. See chart below, which shows a simulation with the impact of a 5% increase in the Fed funds rate on the level of GDP done on a variant of the Fed’s FR/BUS model of the US economy.

In other words, the transmission mechanism of monetary policy takes time, and the drag on growth from lagged Fed hikes over the coming year will be significant. That is why a recession is a more likely outcome than a soft landing, no matter what happens to inflation. 

The market seems to be of the view that if inflation quickly declines to the Fed’s 2% target, then everything will be fine and stocks will continue to go up, and credit spreads will continue to narrow.

There are two problems with this logic.

1) If inflation comes down faster than the Fed expects, it is because the economy is slowing faster than the Fed expects. For example, if wholesale car prices decline more quickly than expected, then it is driven by a sharper-than-expected drop-off in demand for cars.

2) The Fed and academics agree that it takes 12 to 18 months before monetary policy impacts the economy, and this is true both when the Fed is raising rates and when they are cutting rates. So if inflation quickly declines to 2%, we would still have 12 to 18 months of slowing growth ahead of us. 

The bottom line is that no matter what happens to inflation, the lagged effects of Fed hikes will continue to drag the economy down over the coming 12 to 18 months, and that is why a recession is a more likely outcome than a soft landing, see chart below.

Both London and New York are seeing a gradual move back towards normal. London underground usage is 80% of pre-pandemic levels, and New York City subway usage is 70%, see charts below. The rising trends in these charts bode well for a recovery over time in office, retail, and commercial real estate more broadly.

High rates and a slowing economy are creating opportunities for credit investors. Our latest credit market outlook is available here, key charts inserted below.

The housing market is recovering, see charts below and this presentation. With core inflation at 5%, this is a problem for the Fed because it will ultimately put upward pressure on housing inflation and make overall inflation more sticky. Maybe the Fed needs not only a softer labor market but also a softer housing market to achieve its goal of getting inflation back to 2%.

There are cyclical, structural, and policy reasons why the US economy continues to be so strong, see chart below.

The Fed is pressing harder and harder on the brakes, and some indicators are starting to soften in the background, see also the Daily Spark yesterday.

But we are not there yet. The economic data is slowing down and inflation is slowing down. But core inflation is still too high and sticky at 5%.

As a result, the Fed will continue to step on the brakes until they get what they want, namely slower growth and slower inflation.

But the harder the Fed steps on the brakes, the higher the likelihood that we will see a sudden stop in bank lending, capital markets issuance, consumer spending, capex spending, or a correction in financial markets.