Housing the 'epicenter of Fed rate hikes', says strategist

Home prices are starting to tick higher again. That could complicate things for the Fed. Rob Haworth, Senior Investment Strategy Director at U.S. Bank Asset Management Group, tells Yahoo Finance Live there are signs the housing market is adjusting to higher-rate environment.

Video transcript

SEANA SMITH: Well, key employment data out ahead of tomorrow's big jobs report. This month's ADP report showing that private employers added 270,000 jobs in the month of May. Meanwhile, jobless claims for last week rose modestly. Here to break it all down, what this means for the Fed and what this means for the market, we want to bring in Rob Haworth, US Bank Asset Management Group Senior Investment Strategy Director.

Rob, it's great to see you here. So I guess what is your assessment of the labor market right now? It certainly seems like at least for these two reports and the trend that we've seen, the labor market remains very tight.

ROB HAWORTH: Yeah. That's absolutely the case. We still see the labor market as quite tight. I think the interesting thing, as you pointed out earlier, is even though we're seeing consumer spending soften a little bit, it's not coming about because consumers don't have jobs, because we're missing out on jobs.

It's a very tight market. I think the uptick in job openings in April is important and very telling. It was interesting looking deep into the purchasing-- we had a manufacturing purchasing managers survey report this morning from ISM, employment ticked up there as well. So this looks like still a very robust labor market, which should help the consumer kind of work its way through what is a bit of a slowdown, some inflationary pressures, and higher interest rates.

PRAS SUBRAMANIAN: Hey, Rob. So looking deeper at that ADP report, it's a good report overall, but some fragmentation. They mentioned seeing a lot of hiring in leisure, hospitality, but then also a big drop in manufacturing. Is that a concern for you?

ROB HAWORTH: A little bit. But we keep in mind that manufacturing remains a very small part of the economy, and especially a small part of overall employment. Leisure and entertainment remain very large. Services is by far kind of the largest segment of this economy.

And that's really what consumers have missed out on in the last couple of years as we exited the pandemic. We've seen a lot more demand for services activities, leisure and entertainment. I think one of the things we're watching also is, is that starting to slow?

We're not seeing signs yet. Certainly, we heard good news from travel companies as they reported earnings. I guess the question is, does that start to happen at restaurants? Does that start to slow down? But there aren't quite signs that that's happening just yet.

SEANA SMITH: Rob, another big focus, obviously, amongst investors is how the Fed is going to look at tomorrow's jobs report. And what's interesting when you take a look at the lack of the muted market's reaction to the massive swings that we've seen in the Fed funds futures this week-- right now, it's putting a 76 probability that they will hold rates steady at their meeting later this month. Why don't you think we've seen more of a reaction to this swing just in terms of the likelihood or maybe the likelihood that we won't get a rate hike this-- in just two weeks from now?

ROB HAWORTH: Right, yeah, no, just two weeks. I mean, it certainly seems like it. I think the market's been a little more focused on the debt ceiling. We're starting to put that in our rearview mirror, hopefully, here. We get the Senate passage and on we move.

And that's not an issue for us and we can start to focus more clearly on the Fed. I think the interesting thing we've been watching in those Fed prediction markets is we've started to take away expected cuts later in the year. So that seems to imply that people are coming around to this notion that the economy is muddling through OK, right?

We're not on a deep track to a recession. Our economics team is certainly telling us they think we narrowly avoid a recession this year, and that strong labor market, strong spending activity-- or solid spending activity, anyway-- seems to give some credence to that view.

PRAS SUBRAMANIAN: So pivoting the housing a little bit here, mortgage rates sort of surge 7% this week, further kind of worsening housing conditions for buyers. What's your take on the state of the housing market right now?

ROB HAWORTH: Yeah. That really has been the epicenter of Fed rate hikes as we've seen those mortgage rates jump into that 6%, 7% range. That said, we've been at 6%, 7% now for this whole year, and we're starting to see activity stabilize and actually rebound a little bit.

So existing home sales are steady. New home sales are taking a little bit higher. And then we had homebuilder sentiment improve. So that kind of usually portends a little better building activity ahead.

So it looks like the market is adjusting to this new higher interest rate environment and demand isn't really going away. Not only is demand not going away, but we remain really fairly short supplied when we think about the lack of activity that's happened post financial crisis, where we've been building at a very low rate of-- building at a very low rate. And we're kind of falling behind in terms of inventory.

So it's good to see stabilization in housing market activity. And that kind of tells us that the consumer is in a decent spot. And this may be more about rolling slowdowns in activity, as we've seen in manufacturing. Certainly, we've seen manufacturing activity slow down-- then that may be the way we kind of work our way through this challenging time as the Fed leaves us with high interest rates.

SEANA SMITH: Rob, what about what we've seen in the last two months when it comes to home prices? We have seen those start to tick higher. Two months does not make a trend, but I guess how problematic do you think that could potentially be for the Fed here in their fight against inflation?

ROB HAWORTH: Yeah, I think the key thing for us is really around rents a little more than home prices. I think the tick up in home prices is a little bit of a normalization in activity and a signal that we still need more homes, right? And that's part of what we're looking at. The key will be rents, and do rents really start to tick higher?

That's not the case that we're seeing yet. We're seeing these as stabilizing out. And the Fed's probably OK. Now, that said, right, core prices have been in the challenging environment.

But the Fed's really looking at wages to start to slow those down. That's going to be really important data out of the jobs report tomorrow is what happens with average hourly earnings. It looks like they're expected to slow a little bit. Certainly, unit labor costs in the first quarter were slower than people expected. That should help bring down that core inflation and give the Fed some room to pause on rate hikes at some point here this year.

PRAS SUBRAMANIAN: So, Rob, kind of speaking of the Fed meeting coming up in two weeks, we have a lot of volatility surrounding the debt deal, the jobs report tomorrow. With the summer sort of slowdown coming with the markets, what do you sort of want to tell investors where to put their money to play at least for the near term?

ROB HAWORTH: Yeah, in the near term, it really depends upon where you are. I think if you're a fully invested investor, we would still be somewhat defensive heading into the uncertainty of the summer. We'd look to be slightly underweight stocks, slightly overweight real assets, because we think inflation is still a meaningful factor here as we move ahead.

It's not accelerating, but it's not decelerating very quickly. So we'd stay there. If it's someone on the sidelines, we'd have them start to stretch out into taking some risk, particularly along the fixed income curve. So if you're in cash, we'd have you start to move out, take some risk in fixed income, because we think we've seen a lot of the rate increase already.

And so we're seeing some attractiveness in high quality bonds in particular and moving out along that curve. So I think there's room to look. Within the equity sectors, we'd still look towards cash flowing strategies. It's been a fantastic year for technology and secular growth, in contrast to what had been a horrible 2022 for those companies. We'd still be a little more cautious in our portfolio construction there, looking more towards midstream energy, utilities, infrastructure, in particular-- companies that should benefit from reopening activity, but also benefit from slightly higher inflation.

SEANA SMITH: Rob, you mentioned tech there-- the strong, really massive, outperformance that we've seen, and just a couple of names since the start of the year really carrying the market's momentum. Does this worry you at all just in terms of what the second half of the year could potentially look like if we do see some of those gains start to flatten out?

ROB HAWORTH: Yeah. Breadth is certainly a problem for this market in that we have too few names taking the lead. That said, the key really is going to be fundamentals. So expectations for the broad market are that earnings probably slow again in the second quarter.

But we are seeing expectations start to tick higher for full year earnings. And I think if we can get through that second half of the year, we'll turn more to fundamentals for companies as to what is the driver for returns going ahead. And those companies that are able to take advantage of this environment, they've managed their costs well, they're seeing lots of demand-- those improving earnings should benefit them in the back half of the year.

SEANA SMITH: All right, great advice there. Rob Haworth, always good to have you. Thanks for joining us.

PRAS SUBRAMANIAN: Markets kicking off a new month--