Housing starts and initial jobless claims give Fed mixed signals

Builders continued to pull back on the supply of new houses in October amid sharp declines in demand as mortgage rates steepened, the Census Bureau reported on Thursday. The decline came as the labor market continued to show resilience, with initial jobless claims falling unexpectedly by 4,000 to 222,000 last week to remain slightly above the pre-pandemic level, according to Labor Department data. The two reports reflect the different signals that the Federal Reserve is receiving as it tries to tame inflation and cool the economy. On one hand, the housing data shows that the Fed’s aggressive rate hikes are having their intended effect, but on the other, the labor data suggests that the Fed has more room for rate hikes. New starts for residential homes fell by 4.2% to 1.43 million annualized, significantly lower than the level needed to support long-term demand. Most of the drop came from single-family homes as higher interest rates and still-elevated home prices made those homes harder to sell. The housing market has been in correction mode since the start of the year as the Fed has continued to increase rates. Housing starts have fallen by almost 20% since last December. Together with cooling the demand for labor, housing demand remains the Fed’s top priority to tame inflation. But the plunge in housing supply will make it somewhat more complicated for housing prices to fall as fast as the Fed would have hoped for. Building permits—a proxy for future supply—also dropped in October, declining by 2.4% and suggesting that the housing supply is likely to fall further. That drop is aligned with our expectations that the housing market has more room to fall because mortgage rates haven’t peaked yet while the risk of a recession next year is rising. The telltale sign came from the fact that housing starts are about to drop below the number of completions, which in the last two recessions signaled the start of an economy-wide recession. Completions also fell by 6.43% in October to 1.34 million annualized, but unlike residential starts or permits, completions have been stable since January. On the labor front, despite a spate of high-profile layoff announcements in recent weeks, new claims for unemployment insurance—a proxy for layoffs—have remained near historic lows for several months now, a sign of a persistently tight labor market. Claims data is expected to be volatile in the next couple of weeks as the holiday season approaches, and as a result should be taken with caution.