LIZ ANN SONDERS: I'm Liz Ann Sonders.
KATHY JONES: And I'm Kathy Jones.
LIZ ANN: And this is On Investing, an original podcast from Charles Schwab. Every week we analyze what's happening in the markets and discuss how it might affect your investments.
KATHY: Well, hi, Liz Ann. Last week, I was thinking about a couple of topics that have come up recently, I'd love to get your thoughts on. We talked a bit about the housing market. And I know that you're … I think you're in the process of publishing a report on that or going to publish something soon. And what came to mind is there was a comment from Treasury Secretary Bessent saying that they might declare some sort of national housing emergency. And I don't know what that actually means or what would be done if that were to come to pass. But I'm just wondering, you know, it would be great to get your take on the housing market right now.
LIZ ANN: Sure, so yes, we not only are publishing but did publish just about 20 minutes before we both put our headphones on. It hit the website, so it's "Take the Long Way Home." I pulled the little Supertramp reference, and Kevin and I wrote it. It's a look at a number of different facets of the housing market, some of the obvious ones like the trend and trajectory of home sales, both at the existing and new home level, as well as home prices. But we also dive into the supply/demand balances or imbalances. We look at inventory levels and do a bit of a geographic breakdown on those inventory levels, as well as a number of ways of looking at what, to some degree, continues to be a bit of affordability crisis measured in the standard way by looking at indexes that are fairly popular in the world of housing data, like the Housing Affordability Index, which is put out by the National Association of Realtors, but also looking at metrics like how long the average worker has to work, how many hours per month they have to work, to afford the average monthly mortgage payment.
So there's lots of good data and charts in there. We didn't put anything in there about what may or may not be said by the Treasury secretary because we don't know what those details are or what the ultimate goal of announcing that emergency would be, whether that's a sidebar way to add pressure to the Fed. Maybe that's a component of it. We like to remind people on this program—we've talked about it quite a bit, since we've spent a lot of our episodes talking about threats to Fed independence—that a lowering of the fed funds rate doesn't by any means guarantee a lowering in the mortgage rate, because the yield that is most closely correlated to mortgage rates is the 10-year yield, and that is essentially set by the bond market, not by the Fed. So I don't I don't know what the ultimate goal of that declaration if it comes might be, but we didn't address that, and we will, you know, when we get any kind of an announcement.
But I also think that the ultimate kind of, not decider, but we talk about housing affordability as essentially having three components to it, or three legs or pillars of that housing affordability stool. Of course, it's mortgage rates, which we touched on, but also on prices, of course, and then incomes, real incomes and confidence about our incomes. But I'd say there's almost a fourth one that has come into play. In the combined aftermath of the global financial crisis and maybe even COVID to some degree, there has been less willingness to take on significant amounts of debt.
There are debt constraints down the income spectrum, and that's where defaults and delinquencies are picking up, but there's been this greater aversion to taking on additional leverage. And I think that's been one of the reasons why we have seen the housing market relatively weak, even during periods in the past 10 years when affordability was more robust than it is right now. So I think that has to be a considered component when thinking about health of the housing market.
The one thing that is interesting, and I'd love your thoughts on this too, Kathy, is assuming we continue to see a steepening of the yield curve if the Fed does start to lower short rates, but you don't get commensurate movement on the long end, or if you had a repeat of what happened last fall, you get an upward moving yields on the longer end, that would steepen the yield curve. We sort of wondered out loud on paper whether we could finally see some interest again in variable rate mortgages, which I think have represented less than 10% of mortgages in recent years. So I'll toss it back to you just in terms of your latest thinking on what the Fed may or may not do. And if you do anticipate a continued steepening of the yield curve, maybe that does increase the attractiveness of variable rate mortgages.
KATHY: Yeah, we're definitely still looking for that yield curve to stay steep or steepen further. And it's been kind of our call all year here. The expectation is that we'll get at least one rate cut by the Fed. I think more and more, as time goes by and we don't see inflation come down, it's tough to see much beyond one or two rate cuts here and, you know, 25 to 50 basis points total for the time being, unless the unemployment rate really starts to go up or inflation really starts to come down, neither of which seems to be happening anytime soon. And so yeah, I think that you will see long-term rates stay elevated, maybe trickle down a little bit with Fed rate cuts, but you can't really motivate the long end of the bond market to rally unless you've got all the component factors working together, and right now we just don't.
We don't have inflation falling. It's been very sticky, close to 3%, between 2.6 and 3%, say, for over a year now and well above the Fed's target for four years. So we need to see that kind of turn down and show signs of really coming down towards 2% and/or some sort of weakening in the employment market, such that you start to get a rise in unemployment and a significant drag on consumer spending as a result of that, which also hasn't happened. It may happen, but it hasn't happened.
You know, a third factor is that yields are rising globally in most developed markets, and a lot of this has to do with concerns about fiscal policy and what we call a debt trap, meaning you get so much debt you can't climb your way out of it. And that was a worry, if you recall, during the era of the formation of the euro when all of the countries got together, the peripheral countries and the core countries. And it was believed that the so-called peripheral countries like Portugal and Italy and Greece, Spain, their deficits were so high, their debt levels were so high, they could never dig their way out.
Well, it did work out, and they've actually did pretty well, and yields came down, and that worry sort of went away. But now we're back to worrying about the global rise in government debt and who's going to finance it and at what level. Because you don't have, right now, credible plans in place in a lot of countries to address it.
U.K. seems to be in the crosshairs now because they have a budget coming out. But we are seeing other countries. like Germany, people starting to worry because they're going to ramp up spending, but they have very sluggish economic growth. So how do you grow out of your debt if you're spending a lot for defense and for other reasons? And the U.S. has pulled into that as well because we have high and rising deficits. This is not to say that we can't fund debt and deficits. Again, all of the major developed countries have the capacity to do this. It has really been the willingness, a demonstration of the willingness, to do this. And markets will sometimes push and just say, "Hey, I'm going to demand extra yield until I see credible steps to address this." And I think that's the moment we're in right now. And that's going to be hard for housing to deal with.
I don't know how you get mortgage rates to come down if we have elevated debt and deficits and markets pushing back against that. So it's interesting moments.
LIZ ANN: And if, concurrent with that, you still have tariff pressure on inflation, which dents real incomes, which is really the income … it's the real income piece that it matters to housing affordability and things like buying conditions as perceived by consumers.
I wanted to stay on kind of Fed policy here and maybe invite you to play, let's do a little gamesmanship here, play a little game. We've got jobs report coming out at the end of the week. So that is obviously after you and I are recording this right now. By the time this pod episode gets posted, everyone will know what the jobs report was, but we do not at this point. So I'll go to you first.
Just, I've been thinking about, you know, there's lots of numbers you get in the jobs report. It's not just the payroll number. It's not just the unemployment rate. There's a lot of innards and sub-content that is sometimes just as valuable as the headline numbers. But just in general, I've been thinking about what type of report would either be really detrimental to the equity market or beneficial to the equity market, or maybe there's some sort of equilibrium that doesn't … that means it's not much of a market-moving event.
So I'll toss it back to you in terms of maybe the same question. What do you think could be a big needle-mover one direction or another in the bond market, in yields, with what gets announced this upcoming Friday?
KATHY: That's a great question, because as you mentioned, there's a lot of different components to it. I think the bond market would love to see the unemployment rate stay steady-ish, you know, up maybe a tenth of a percent, a negligible amount. Job growth positive but moderate, maybe only 50,000, 60,000 jobs added. That would suggest we're in a slowing environment for hiring, but not in a recession where it's contracting. And then wage growth that's only moderate, maybe two-tenths of a percent, indicating that the workers aren't getting massive increases to compensate for inflation, and therefore there's not this kind of cycle of inflation and being chased by higher wages.
I think that would indicate some sort of equilibrium at a lower level that we've gotten to and calm the market. And the market would say, "Oh yeah, there's room for the Fed to cut rates, but not too much." So pretty good. We're not falling into recession, but we're not taking off. I think that would be kind of nirvana for the bond market. Now, we haven't seen nirvana very often in markets, so I'm not betting on it one way or another.
But I think that that would be something the market would like to see and would allow rates to come down a bit. What about you in the equity market, though? What are you looking for?
LIZ ANN: Yeah, I think there's the Goldilocks-type of report as you laid out in terms of sort of an inline payroll, still positive, but not through the roof and an unemployment rate that even if it ticks up, it's fairly mild, not a big decline in household employment. We have to remember that when the Bureau of Labor Statistics reports the jobs numbers, it's their establishment survey that generates payrolls. And another sidebar on that payrolls note is, as many remember, last month's jobs report had, you know, a bit of a weaker headline reading, but the big jaw-dropping component of that report was the prior two months revisions to payrolls, which were significantly lower, so I'd say it's the revisions that matter, too.
But something that is generally in line, weak enough to continue to support a Fed moving to easier policy starting this month. That said, I think, to me, a really, really weak report, notwithstanding what that might do to cementing odds of the Fed easing, maybe possibly even bringing back into the probability spectrum 50 basis points or maybe having more rate cuts expected nearer term.
I think any concerns about recession, I think, would offset the benefit accrued to the equity market from easier-than-currently-expected Fed policy, because I think what is priced into the market, the equity market, right now is the Fed starting to ease. What is not priced into the equity market is a recession. And I don't think there's really a fine line between those two.
So I think a really weak report, I think even if there was a quick knee-jerk positive reaction if you saw Fed rate cut odds change, I think would not be a positive. And then of course the other side of that would be an extremely positive report where, you know, the revisions are the opposite of what we saw, and those downward revisions get revised away, who knows? I think that that that likelihood seems to be fairly low based on all of the leading indicators of the labor market. That's the one I have a tough time trying to figure out what the equity market would do in the short term to a really, really, really strong number.
KATHY: Well, I mean, would there be an assumption that the new head of the Bureau of Labor Statistics had somehow fiddled with the numbers? And I only say that because we've now raised the prospect that this is more of a political issue to look good. And do you think the market would jump to that assumption if it was just too good to be true?
LIZ ANN: Well, we don't have a sitting head of the BLS now, right?
KATHY: I think someone was named. I don't know if that person's been … confirmed.
LIZ ANN: Was named, but doesn't that require Senate confirmation? So not confirmed yet.
KATHY: Yeah.
LIZ ANN: But yeah, I mean, that's … we've also spent a lot of time on this pod talking about efficacy of data and the fact that even before this latest sort of brouhaha with the BLS and more direct threats to Fed independence, you and I had started to get questions at client events months ago about data efficacy. And at some point, is it possible that we might not trust the data that's coming in?
So yeah, I think you're absolutely right that it would … I think a very clear conclusion that people might come to might be that, "OK a new interim head is put in even without Senate confirmation, could the numbers not be actually valid numbers?" So that would be another angle, and I don't think that the equity market would take kindly to that assumption.
KATHY: I'm sure the bond market would not, but you know, fortunately we do get some other data on jobs before, you know, we get the ADP numbers, and those, although they're not highly correlated, you do get a read in private sector hiring. So those numbers give us kind of a temperature check anyway.
LIZ ANN: And we're getting the JOLTS data, too, which is the Job Opening and Labor Turnover Survey. And that has a lot of subcomponents. There's the headline job openings, but then there's a metric called the quits rate, what percentage of workers are voluntarily quitting. That often signals that there's confidence in the labor market, and you get layoff announcement details. We also get the Challenger layoff announcements coming out. And that's something to keep an eye on for obvious reasons, because we've been in this pseudo-equilibrium of this kind of low-hiring, low-firing backdrop. So any sort of shaking of that equilibrium, I think, could be attention grabbing. Anything else on your radar … don't we also get, next week, I think we get both CPI and PPI, Consumer Price Index and Producer Price Index.
So the Personal Consumption Expenditures index version of inflation, which is the Fed's preferred measure, came out last week. And it was pretty much in line with expectations, although it generally comes in in line with expectations because once you get the Producer Price Index and the Consumer Price Index, you can do the math and figure out to about an 80% accuracy what the Personal Consumption Expenditures is going to be, but I guess we would maybe add that to how we're gaming things, that if you were to get a better-than-expected employment number plus hotter inflation, that would probably change the outlook for Fed policy. I guess worst-case scenario would be a really ugly employment report and then a hot set of inflation readings, because then that brings the whole stagflation notion back into the zeitgeist.
KATHY: Yeah, I wouldn't rule that out as a possibility, just because we do have the whole tariff impact just kind of gradually making its way through the system. And we could get some bad inflation readings based on that. Interestingly enough, as you mentioned that, I was just looking at some of the Taylor Rule metrics. And for people unfamiliar with the Taylor Rule, it's named after John Taylor, a Stanford University professor who tried to estimate the balance between the unemployment rate and inflation and come up with an equilibrium fed funds rate that would balance the two because the Fed is mandated to try to balance employment and inflation.
And as I was looking at the recent estimate, obviously, there's a lot of inputs and there's a bunch of modifications now to the Taylor Rule, so you can change your assumptions and change the outcome, but I was looking at the recent ones produced by the Federal Reserve Bank of Atlanta, which keeps a nice little heat map of this. And it indicates that the fed funds rate is pretty much close to equilibrium right now. It's pretty much where it should be, or it could be higher, just tinkering with some of the inputs.
And so I have trouble seeing how much room the Fed has to lower rates. I do think they will cut because they're telling us they're going to cut. And I do think the economy is set to slow down to some degree, but I'm troubled by the fact that the market has built in a whole cycle of rate cuts over the next year or so. And yet it's not really showing up in the data. And if the current fed funds rate is just about where it should be, or there's room for just a little tweak, that the market could be very disappointed as we get into 2026 by how much the Fed doesn't cut rates.
LIZ ANN: Yeah, one final thing that just popped into my head as we were talking about all the economic data: a plug for my X feed, Twitter feed, whatever we're calling it. Every Monday, or in this week's case, Tuesday, I post a table that Kevin and Adrienne put together. And I always call it this week's data dump. And it's just all the economic reports due out in the week ahead and all the prior readings and all the consensus expectations. So it's a nice kind of cheat sheet you can look at the beginning of each week to gauge how the data is coming in. It's one-stop shopping, so to speak.
KATHY: Yeah, I often refer to that when I'm getting up on Monday morning and trying to figure out what's going on this week.
LIZ ANN: What's next?
KATHY: Yeah, I don't have to look too far to find it, so it's well appreciated.
LIZ ANN: Thank you. So that's it for us this week. Thanks as always for listening. You can always keep up with us in real time on social media, as I already mentioned. I'm @LizAnnSonders on X and LinkedIn. Still have lots of imposters, so make sure you are following the real me.
KATHY: And I am @KathyJones—it's Kathy with a K—on X and LinkedIn. And you can always read all of our written reports, you know, full of charts and graphs and other good graphics to grab your attention, at schwab.com/learn. If you've enjoyed the show, we'd be really grateful if you'd leave us a review on Apple Podcasts or rating on Spotify or feedback wherever you listen. And please tell a friend about the show. We'll be back next week with another episode.
LIZ ANN: For important disclosures, see the show notes or visit schwab.com/OnInvesting, where you can also find the transcript.