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California labor markets signaled full steam ahead in the latest jobs report released Friday with hiring posting its best showing in 6 months. However, the underlying details suggest that things may not be as rosy as the headline numbers suggest, which may help to provide cover for the Fed to lower rates later this year. With inflation slowing further in July, mortgage rates continue to rally, and homebuyer demand is finally approaching positive territory for the first time since rates began to rise in 2022. Mortgage delinquency rates remain very low in California and the percentage of homeowners with significant equity to stave off foreclosure in a worst-case scenario remains remarkably high. Fundamentals are also bolstered by the fact homeowners currently have very attractive mortgage payments, with roughly two-thirds of the state in a 4% rate or lower (90% of which are fixed-rate loans).
Inflation is still creeping toward the Fed’s target last month: For the second month in a row, headline inflation was below 3% on a year-to-year basis with July dipping slightly from June. This has helped to bolster hopes that the Federal Reserve will lower interest rates at their meeting in September. More importantly, core inflation, which excludes certain volatile items, continued its downward trend last month as well. However, service sector prices, wages, and housing costs remain stubbornly high, which prevented more robust progress in the Fed’s war against inflation. While headline inflation is likely to approach 2.5% this year, we expect the declines to remain incremental.
Mortgage rates essentially unchanged below 6.5%: The latest Freddie Mac interest rate for a 30-year fixed-rate mortgage remained below 6.5% for the second week in a row, though this figure was released prior to the latest inflation reading last week. Rates have now been below 7% for the past 11 weeks, consecutively, and the bond market is not indicating any near-term reversal of course as 10-year Treasuries remain below 4% currently. In addition, the yield curve is less inverted now than it has been since the Fed began raising rates, which suggests that the bon market is becoming more optimistic about both a rate cut in September as well as a soft landing for the economy.
Buyer demand on the upswing despite seasonal slowing: California typically sees home sales peak in the summer as homebuyers who entered escrow during the so-called “homebuying season” close their transactions prior to school resuming in the fall. This year has followed that typical seasonal pattern, meaning that home sales are beginning to return to lower levels before picking up again next spring. However, when controlling for typical seasonality, homebuyer demand is showing some signs of life. Mortgage applications last week, though still dipping, had their smallest decline this year and their second smallest decline since rates began rising in 2022. In addition, pending sales in July responded sharply to the recent reprieve in rates and should translate into a solid homes sales report in August.
Looks can be deceiving in the latest jobs report for California: California’s labor market had another strong month in July. With 21,000 net new jobs added, last month saw the biggest increase in nonfarm employment since January. However, below the surface, details suggest that the labor market may not be as strong as the headlines would suggest. First, nonfarm jobs are based on a survey of employers and can reflect multiple new jobs even if, theoretically, all of those jobs were filled by a single worker. Recent studies suggest that some workers are picking up multiple jobs, which could inflate overall job growth. Second, and relatedly, the survey of households shows starkly different results. While nonfarm jobs have been rising for 11 of the past 12 months, the number of workers that are employed has fallen by roughly 100,000 over the past 18 months and the number of unemployed workers has gone up by even more: from 858,000 in January last year to over 1 million last month. Even the composition of the 21,000 we did create looks much different than it did 18 months ago with our top 5 largest metros (which account for nearly two-thirds of California’s jobs) growing by an average 1.5% compared with an average of 2.8% in our 10 smallest metros (which only account for 4% of our labor market). This suggests that economic activity could be revised downward later this year, which may help to support additional/larger rate cuts by the Federal Reserve later this year.
Chance for unseasonably strong winter housing market: In addition to the positive response to the housing market as rates have dipped below 6.5%, several other factors could help to heat up California’s housing market during the holiday season. The recent jobs data suggests that a weaker economy may help the Fed to deliver lower rates this winter. The presidential election could also have an effect. Results on the impact of national elections on the market tend to fail most statistical tests, but there is anecdotal evidence that elections could cause the fall housing market to be slightly weaker and then making those sales up in winter as buyers who delayed their purchase until after the election jump back into the market. If inflation continues to improve, the labor market weakness begins to show up in other indicators, and the post-election bounce holds true, California could enjoy an unseasonably strong winter this year.
