Mortgage Rates And Falling Oil Prices | ITK With Cathie Wood

As we navigate the economic landscape following an eventful turn of the year, investors and consumers alike are faced with a complex paradox. On the surface, the United States economy appears robust, boasting real GDP growth rates exceeding 4% in the third quarter and projections suggesting continued strength. Yet, underneath these headline numbers, significant sectors of the economy remain in a contractionary state. This divergence suggests that while we may have avoided an official recession thus far, we are navigating a "rolling recession" that is shifting from sector to sector.

Understanding this dynamic is crucial for interpreting conflicting economic signals, from mortgage rates to consumer sentiment. By analyzing the underlying data—ranging from oil prices and housing inventories to the rapid adoption of artificial intelligence—we can build a case for a future that looks vastly different from the consensus view of persistent inflation and stagnation.

Key Takeaways

• The Rolling Recession Persists: While headline GDP is strong, critical sectors like housing and manufacturing have faced significant contraction, creating a disconnect between economic data and consumer sentiment.
• Deflation Over Inflation: Contrary to consensus expectations of sticky 3-4% inflation, declining oil prices, housing adjustments, and soaring productivity suggest inflation could surprise to the downside, potentially turning negative.
• Productivity Boom: A resurgence in productivity, driven by AI and technology, is suppressing unit labor costs, effectively neutralizing the threat of 1970s-style cost-push inflation.
• Policy Impact: Shrinking twin deficits (trade and budget) and competitive corporate tax rates are setting the stage for a potential "Goldilocks" economy of high growth and low inflation.
• Asset Allocation Shifts: With gold reaching historical extremes relative to money supply and Bitcoin demonstrating low correlation to other asset classes, the investment landscape is evolving in response to global monetary shifts.

The Paradox of High GDP and a "Rolling Recession"

The economic narrative of the past three years has been defined by a rolling recession. While aggregate GDP growth has remained positive—recently clocking in at over 4%—specific sectors have endured severe downturns. This explains why, despite strong macroeconomic data, consumer sentiment remains at levels comparable to the 2008 financial crisis or the inflationary peaks of 1980.

The Housing Market Freeze

The most visible casualty of recent monetary policy has been the housing market. The Federal Reserve's aggressive rate hike campaign, which saw the Fed funds rate jump from 0.25% to 5.5%, effectively crushed housing activity. Sales volumes plummeted to levels not seen since the late 1970s, despite the U.S. population growing from roughly 220 million to 340 million in that same timeframe.

However, policy shifts may be on the horizon. Recent discussions regarding government intervention—specifically the potential purchase of $200 billion in mortgage bonds—aim to lower interest rates and address affordability. While $200 billion is a modest figure relative to the total mortgage market, it signals a clear policy focus on housing affordability. We believe the housing market is setting up for a significant rebound, driven by a combination of falling interest rates and necessary price adjustments.

Manufacturing and Consumer Sentiment

Ideally, manufacturing serves as a leading economic indicator. For nearly three years, the U.S. manufacturing sector has been in contraction, marked by an ISM index below 50. This prolonged slump is highly unusual; manufacturing corrections are typically short and sharp. The extended nature of this contraction suggests that the "rubber band" is stretching, potentially leading to a sharp rebound in production over the coming year.

This sectoral weakness contributes to the bleak mood among consumers. Sentiment metrics, particularly for lower-income groups, are historically poor. While the headline unemployment rate appears low, cracks are forming. Notably, the unemployment rate for the 16-to-24 demographic has risen to 12%, a double-digit figure that highlights the uneven nature of the current economic environment.

The Deflationary Undertow

Perhaps the most contrarian position in the current market is the outlook on inflation. While the consensus expects inflation to remain sticky in the 3% range, a deep dive into the data suggests a powerful deflationary undertow is building. This is driven by three primary forces: oil, housing, and unit labor costs.

Energy and Housing Prices

Oil prices serve as a critical tax on the consumer. Currently, oil is down 15-20% year-over-year. If global supply dynamics shift—such as increased imports from Venezuela diverting supply to the U.S.—we could see West Texas Intermediate (WTI) prices disconnect from Brent crude, driving domestic oil prices down by more than 25%. This acts as a significant tax cut for consumers and directly impacts headline inflation.

Similarly, shelter costs, which comprise a massive portion of the CPI, are poised for correction. New home inventories are rising toward levels seen before the 2008 crisis, forcing builders to cut prices rather than just offer rate buydowns. These price reductions in the new home market will inevitably bleed into existing home prices and rental metrics, dragging inflation numbers down further.

Productivity vs. Cost-Push Inflation

A common fear among economists is a return to 1970s-style cost-push inflation, where rising wages drive up prices. However, the current data contradicts this fear. While compensation has risen by roughly 3%, productivity has surged by 4.9%.

When productivity grows faster than wages, unit labor costs decline. Currently, unit labor costs are falling, a phenomenon rarely seen outside of the early 1960s. This productivity boost acts as a natural cap on inflation, allowing the economy to grow without overheating.

Growth does not cause inflation. In fact, productivity-driven growth is associated with falling inflation.

Fiscal Discipline and "Turbocharged Reaganomics"

The policy backdrop is also shifting in ways that support a low-inflation, high-growth environment. The federal budget deficit, which ballooned to 17% of GDP during the pandemic, has retreated to approximately 5%. While still elevated, the trajectory is improving. The objective of reducing the deficit to 3% of GDP seems attainable through spending restraint and economic growth.

Simultaneously, the U.S. is witnessing a shrinking trade deficit, driven largely by a sharp decrease in imports. This improvement in the trade balance is mathematically boosting GDP. While some argue that trade deficits are inherently bad, a trade deficit often signals that the U.S. is growing faster than the rest of the world and attracting foreign capital.

On the tax front, the effective corporate tax rate has dropped to roughly 10%, the lowest in the developed world. Combined with accelerated depreciation schedules that allow manufacturers to expense capital investments in year one, the U.S. is becoming an increasingly attractive destination for foreign direct investment. These policies echo the strategies of the 1980s but are adapted for the modern, digital economy.

Innovation, AI, and Capital Spending

We are witnessing a breakout in non-defense capital goods orders, particularly those associated with technology. After years of stagnation, capital spending is reaching all-time highs, driven by the "ChatGPT moment" and the aggressive build-out of AI infrastructure.

This technological revolution is the engine behind the productivity numbers mentioned earlier. For the younger generation, often referred to as "AI natives," this presents a unique opportunity. Despite higher youth unemployment rates, the barriers to entrepreneurship have never been lower. Tools like ChatGPT can now assist in drafting business plans, marketing strategies, and sales protocols, empowering individuals to start businesses with minimal overhead.

This surge in innovation is inherently deflationary. Technology allows companies to produce more for less, driving down prices while expanding market reach. This "good deflation" stimulates unit volume growth, which can lead to robust earnings even in a lower-price environment.

Market Outlook: Gold, Crypto, and Equities

The financial markets are sending mixed signals that require careful interpretation.

Gold and Bitcoin

Gold prices have surged, with the market capitalization of gold relative to U.S. M2 money supply surpassing levels seen during the high-inflation era of the early 1980s. This suggests that gold may be pricing in extreme scenarios. Conversely, Bitcoin continues to exhibit a low correlation with traditional asset classes, including gold, bonds, and commodities. This lack of correlation reinforces its value proposition as a diversifier for institutional asset allocators.

Equities and Valuation

Valuations for the S&P 500 remain elevated, but context is key. Historical data shows an inverse relationship between inflation and P/E ratios; as inflation falls, multiples tend to expand. If the view on deflation holds true, current valuations may be justified.

Furthermore, if we are indeed entering a period of productivity-driven growth, corporate earnings could accelerate rapidly, compressing valuations over time. The "Goldilocks" scenario—characterized by strong real growth, low inflation, and falling interest rates—creates a favorable backdrop for innovation-focused equities.

Conclusion

The economic data points toward a dramatic shift. The rolling recession is likely to resolve into a broad-based recovery, fueled by interest rate relief and a manufacturing rebound. Importantly, the fear of runaway inflation appears misplaced. The convergence of falling energy prices, housing corrections, and a productivity boom suggests that the greater surprise will be how low inflation can go.

We believe we are entering a period reminiscent of the 1980s and 90s, where innovation drives growth and keeps prices in check. As the economy transitions from contraction to expansion, the stage is set for a productivity-driven boom that could confound skeptics and reward those positioned for a low-inflation, high-growth future.