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Written by: Tim Pierotti
Sometimes bad is good and good is bad when it comes to markets and the economy. Now is one of those times. Housing is critical to the US economy. In virtually every presentation I’ve given to financial advisors over the past couple years, I’ve repeated the economic mantra that “Housing is the Business Cycle”. Recent data suggests the housing market is finally starting to weaken following robust growth in new construction and prices over the last four years. Pricing is finally beginning to show real weakness in about half the country. Zillow expects to see home prices down 2% nationally in 2025 and according to Case Shiller, prices are already down 3% over the past three months. The supply of completed but unsold homes is the highest since the Great Financial Crisis. So how is this a good thing you ask? Timing is everything. The weakness in housing is providing the economy with a disinflationary force that is offsetting the goods inflation stemming from tariffs.
According to Bill Dudley, the former Goldman Sachs Chief Economist and former President of the Federal Reserve Bank of New York, the inflationary pressure from a 15% rise in the average tariff rate from 3% to 18% should result in an inflation rate increase of about 1.5%. In other words, Dudley believes that over time, as the tariffs are passed through to the US consumer, the impact to the inflation rate will settle at 1.5% higher than it otherwise would be. Considering the Fed targets an inflation rate of 2%, 1.5% of incremental inflation will make the Fed’s job much harder.
On Wednesday, at the press conference that follows the FOMC (Federal Open Market Committee) Chairman Powell responded to a question about tariffs by saying that the Fed is, to some degree, looking through tariff pressures or else they would be raising rates. He makes a fair point given core CPI is at 2.9% y/y and rising and PCE is at 2.8% y/y. Others on the committee obviously disagree as this was the first time in over 30 years that the unanimity seeking FOMC had two dissenting votes. Bowman and Waller, the Governors who voted to cut rates, see the economy as weakening at a concerning rate in large part due to the weakness in housing and the potential impact that will have on an already softening employment picture.
Our guess is that the disinflationary impact of housing will continue to offset much of the inflationary impact of tariffs. Housing and goods each represent about 40% of CPI. As long as housing doesn’t start to fall apart, and I don’t see why it should given the extraordinary fiscal spending backdrop, we could thread the needle. We could see an extended period where the economy sees weak but not recessionary growth and the softness in housing allows the Fed to not raise rates in response to tariff driven inflation. The risk is that the stagflationary picture accelerates further. Currently, we have an economy with slowing demand growth and rising costs. Historically, that has been terrible for risk assets, but history hasn’t been much of a guide lately. We’ll see. As John Kenneth Galbraith taught us, “The are forecasters who don’t know and those who don’t know they don’t know”. We are firmly in the former camp amid an environment where far too many market participants are in the latter.
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