Thursday, September 18, 2014

Follow up on August inflation, etc.

Several sets of data were updated today, but the picture remains muddled.

The flow of funds data continues to show a decline in household mortgage levels.  Commercial, corporate, and multi-family mortgages are slowly growing.  But, households are stagnant.  The growth in real estate loans at commercial banks may just reflect a slight rebalancing from MBS levels into held real estate loans as a result of the QE taper.  I'm not sure we are seeing any growth in household real estate credit.  And, the level of equity compared to total market value leveled out in 2014 2Q.  At the previous trend, I was somewhat optimistic about recovery in the level of real estate leverage to help re-establish household real estate credit markets.  But, looking at this with fresh eyes, and with the decline in trend, this is troubling.  We need another year's worth of healthy home prices for this balance to be restored.  Without QE, I'm not sure where that is going to come from.  Maybe continued rent inflation and the recovery of bank balance sheets will continue to support funding for institutional home buyers.  But, there is a risk here that housing markets don't recover.  Interest rates may be stuck at zero if housing markets can't  recover.

Source: Calculatedrisk

By the way, August housing starts disappointed, and continued to show a stagnation in home building.  I may be getting ahead of myself on my homebuilder optimism.  We may have a ways to fall before things turn around.  If the economy manages to grow in spite of a lagging home market, multi-unit real estate might see unexpected growth as it fills in the gap on the supply bottleneck.

I wonder if this is the source of pessimism that has held the slope of the yield curve so low.  I have been positioned for a steeper slope.  This is definitely a situation where the market price must reflect divergent potential outcomes.  The yield curve where it stands now might reflect two extreme possibilities - future rates much higher than the current rates (in the 2016-2017 timeframe, at least) or future rates that never get off the ground.  Or, worse yet, rates that rise because the Fed tightens when it shouldn't, and then drop to the floor along with the economy.  I will note that the change in the yield curve Wednesday, when the Fed published their latest position, reflected increased rates in 2015-2018 and decreased rates in the long term.....

Reminiscent of the September 2008 Fed meeting, where the Fed's head trader told the FOMC:
I think it is important to recognize that the rates embodied in those fed fund futures contracts are means not modes. So I would characterize the market expectation as either that things get very, very bad and the FOMC cuts rates significantly or that the FOMC does nothing.
Of course, the Fed did nothing, and thus things got very, very bad.  So, the market was actually right on both counts.  Is this what the market is telling us again, but this time in slow motion?


On the brighter side, the productive economy seems to be moving right along.  Unemployment claims continue to decline.  Continued claims have fallen well below 2.5 million now.  This suggests a baseline expectation for unemployment that has declined another 0.1% from the August number, increasing the chance of hitting year end with a 5.5-5.7% unemployment rate.

It is looking like we might be headed for an end of 2014 where employment, production, and incomes are churning along nicely, but where single unit real estate stagnates.  An interesting time ahead, I'm afraid.

PS I've added a time lapse of Eurodollar futures to show the change in rates as QE3 has tapered.


  1. TravisV from TheMoneyIllusion comments section here.

    If the Fed has pulled back the reins too early, then why is the S&P 500 at 2,011?

    1. Travis, don't let the permabear worm infect your brain. Markets go up. That's what they do - especially in an era when half of the return of capital is coming in the form of share buybacks. Monetary policy can't make them go up any more than they should have. It can make them go down.
      I'm not sure what effect the current policy is having on the stock market. It is screwing up the real estate market, though. Given the option, baby boomers preferred a growing exposure to real estate. They haven't had that option since 2007. I assume that we would all be better off if they had that option. It would allow capital markets to clear at undistorted prices again. But, I don't know what all the effects on the stock market would be.

    2. TravisV here.


      Three weeks ago, the yield on the 30-year treasury was 3.08%. Today, it's at 3.29%.

      I'm not quite buying your story just yet.

    3. I'm just glad you understand what I'm saying and you're here trading notes. I'm just trying to figure things out, not trying to convince you. If I'm wrong, I hope you convince me!

      I've added a graph to the post to show forward Eurodollar rates during the taper. They declined across the board until after May. Long term rates have remained low. All the increases have been on the short end of the curve.

  2. Everytime I see your blog, I want to go to the Grand Canyon again. What a place.

    1. Believe it or not, that's Dead Horse Point in Utah. Utah might be the best kept secret in the west. At least it's the best kept one that I know about...

  3. I'll be danged. Thought it was the GC. Desert scenery---wow.