Interest rates hover near the best levels since September, despite several good economic readings reported. Let's discuss what happened and see what is coming next week.

"Hey, alright now And don't it feel good" - Walking on Sunshine by Katrina and the Waves

Economy Grew to Finish 2022

Gross Domestic Product, a measure of economic growth, for the Fourth Quarter 2022 showed the economy expanded at a 2.9% annual rate, down slightly from the 3.2% rate in the Third Quarter 2022. Seeing the economy grow in the back half of 2022 after negative growth in the first half of 2022 is good news.

This positive reading elevates the chance of a "soft landing" by the Fed, where they hike rates to slow inflation but do not slip us into a recession.

Unemployment Line is Historically Short

Initial Jobless Claims for December came in at 186,000...the lowest reading in 9 months. This is also good news as it tells us the length of the unemployment line. If the amount of people signing up for first time unemployment benefits remains near historical lows, it further lowers the chance of a recession. Moreover, it highlights the continued strength in the labor market, and this is paramount as jobs buy homes. Yes, we want interest rates to move lower but if someone doesn't have a job or is in fear of losing their job, they can't commit to a home purchase. Let's hope the labor market remains strong as the Fed continues to hike rates to slow demand and lower inflation.

New Home Construction Costs Coming Down

The National Association of Homebuilders reported that building materials costs, less energy, are up 8.3% which is a big increase annually. However, the price growth is down a staggering 60% as input costs increased over 16% in 2021.

We should expect input cost growth to slow further in response to slower demand and further reopening of supply chains. This is another positive theme as we move through 2023.

Smaller Fed Rate Hike Still Priced In

One of the headwinds to the economy is the threat of higher short-term rates by the Federal Reserve. The good news there? After four consecutive .75% rate hikes, followed by a .50% hike in December, the financial markets are fully pricing in a smaller .25% hike at next week's Fed Meeting.

The markets also believe the Fed will raise rates by another .25% in March and then pause to allow all the hikes that date back to last summer to seep into the economy.

This means the Terminal Rate, or the fancy way of saying the peak in the Fed Funds Rate, is going to be in a range of 4.75- 5.00%. From there we will have to continue to watch the standoff between the Fed who says they want to keep rates higher for longer. Additionally, with no rate cuts this year versus the financial markets, which are starting to "price in" as many as two rate cuts later this year.

Bottom line: The economy is showing mixed signals, but the labor market remains strong, and we are nearing the end of Fed rate hikes. So, the plan to land the U.S. economy softly and avoid a deep recession remains very much in play. That is good news for housing and the economy.

Looking Ahead

Next week is Fed week. As of this moment, the markets fully expect the Fed to raise rates by .25%. Anything other than that would be a surprise and generate a lot of market volatility. The Fed generally looks to avoid sending the market mixed signals but the markets will be on edge.