Friday, April 17, 2015

March 2015 Inflation

Core minus shelter inflation appears to have bottomed out.  We have three straight months of C-S inflation at 0.1% or higher for the first time since 2Q 2014 and March C-S inflation came in at 0.2%, which is the highest reading for a single month in more than 2 years.

Shelter inflation for the month was 0.27%, which is about the trend level we have seen since the mid 1990s, except for the aftermath of the 2008 crisis, where the drop in incomes became sharp enough to cut into housing consumption.  I attribute this to a long-running shortage in housing, which was only partially mitigated during the housing boom of the 2000s.

The post QE mortgage recovery story continues to look plausible.  One danger was that non-shelter inflation would continue to fall, and that the economy wouldn't have the legs to keep recovering without QE.  I think the economy is close enough to systemic recovery now that real interest rates and real wage growth should be strong enough to allow for non-distorted economic activity even if inflation is somewhat soft.  The danger was mainly in sharp deflation.  It looks like we have avoided this.  Forward inflation expectations appear to have stabilized, also.

If mortgages begin to expand, we should see a convergence of shelter inflation and non-shelter inflation.  (This convergence will probably be associated with rising home prices, which will be erroneously associated with housing inflation.)  This happened from 2002 to 2005, also.  This should buoy real incomes and help keep the Fed from throttling liquidity, until the "bubble" police start begging for some more self flagellation.  As long as liquidity is made available, returns (and prices) of homes and real long term bonds should also converge to long term trends.

A commenter at The Money Illusion recently noted two articles from 2001 and 2002 that were already declaring a housing bubble.  The commenter meant this as evidence that there was a bubble and that it was something regulators could have foreseen.  Of course, anyone who bought a house in 2001 or 2002 would have done quite well, and would still be sitting on substantial capital gains.  From my perspective, those articles are evidence of how the bubble narrative was preordained as an explanation for any economic dislocation, well before the events of the boom and bust played out.

Those two articles (especially the second one) contain several common anti-finance shibboleths.  From the first article:
Supply is beginning to outstrip demand...(Robert) Shiller worries about an ominous mix of overdevelopment, inflated home prices and rising consumer debt.
From the second article:
(H)omeowners have every reason to keep their homes expensive. And, by coincidence or design, as home-equity finance has gained popularity, so too have no-growth movements, restrictive local zoning laws and other policies that constrain new-home construction.Demand soon outstrips supply. 
Both of these things, as any sophisticated observer will tell you, are products of some sort of conspiracy of some group of financial interests (builders, rich homeowners and investors, etc.) to keep pushing their "paper" profits up.  Paper profits, of course, being a sort of "Wall Street" demon pretender of the sort of incomes and gains that real people create.  We know that the economy is composed of (1) Wall Street power brokers whose machinations, even when they are direct contradictions of other supposed machinations, push prices to and fro, for the sole benefit of financial insiders and "the rich" and (2) helpless rubes who, as a group, chase bubbles, like addicts, in a fruitless attempt to escape their ever-descending economic state.  These things, we know, a priori.

The red team/blue team drama has latched on to these notions, which are firmly rooted in banal cognitive biases, because it allows for much more predictable arguments about cause.  If our understanding of outcomes is allowed to adjust for experience and empirical review, political debate will be complicated.  If we can all agree on unchanging, false premises, then we can get to the important work of arguing about whether the canard was the fault of Republicans or Democrats.  And, since most of these markets involve complicated tradeoffs, we can all agree on things, like, that rising home prices are lining the pockets of the 1% while they also simultaneously make it harder and harder for working families to afford a home.  Every transaction includes a buyer and a seller, which is sort of like magical pixie dust for populist rhetoric.

Only a naïf would suggest that prices are, you know, information about underlying economic fundamentals, or that reasonable people, upon witnessing a massive increase in prices among the most widely distributed middle class asset, might consider it a sign of a very healthy middle class.

....Anyway, I'm getting off track here.  As in the 2000s, where markets function, prices tend to get corralled into fairly efficient equilibriums, even when there is pretty widespread conscious irrationality.  So, as long as liquidity is somewhat reasonable, this convergence should be fairly inevitable.  But, since these irrationalities are expressed politically, there is a decent likelihood that we will see another dislocation eventually.  But, until that happens, the return to real estate should converge to the long term relationship with real bond returns, as shown in this graph.  (Bond returns were probably higher in the 1980s because nominal bond yields reflected an inflation uncertainty premium.  However, if that wasn't the case, then this long-term relationship would suggest that home prices were too high in the 1980s and 1990s and were normal in the 2000s.  I don't think anyone argues that.)

Bond and home prices are about 2% away from their widest typical relative returns.

As mortgages expand, home prices should rise, creating a sort of virtuous cycle of liquidity creation.  Forward inflation expectations of about 2.5%, with real long term interest rates around 1.5% (nominal rates of 4%) would equate to real estate yields of about 3% - 3.5%, which would be associated with a decent rise in nominal home prices.

Weekly readings in the Fed's H.8 report on bank assets can be a bit noisy, but this week's numbers seem to confirm a new growth rate that is kicking up toward 1% per month.  This graph shows Closed End Real Estate Loans outstanding, both seasonally adjusted and not adjusted.

There is a monthly cycle with these loans, and the March to April comparisons have been strong.  All in all, I'd say today's reports are tentatively good news.

1 comment:

  1. Nice blogging.
    Seems like a few in the indicators now flashing yellow. Time will tell.