Wednesday, December 14, 2016

Interest Rate Signals

I see a lot of talk about the inflationary effects of some policies Trump may propose, and of course interest rates have risen surprisingly since the election.  But I noticed an interesting pattern.


The rise in inflation expectations began in September, and has been pretty stable.  The rise in real rates shot up after the election, and now has started to retrace a little bit.

Also, the rise in inflation expectations seems to correspond to a rise in food and energy inflation, but at the same time, core inflation outside of shelter has been falling.  It's heading back to 1%.  So, does the rise in CPI signal a coming rise in core CPI?  The TIPS market seems to think so.

I'm still unsure.  Will the rate hike be more contractionary than it is expected to be, leading to an eventual reversal in inflation expectations?  Or, is this a de facto monetary loosening through a sort of fiscal expectations channel, and now rate hikes will be less contractionary than they would have been.

I will be very curious to watch rate movements after the hike.  In the meantime, my indecisiveness may be costing me some trading gains.  Not sure what to think here.  I think because of the zero lower bound, we are later in the rate hike cycle than it looks, and in a position where raising rates into falling core inflation is ill-advised.  But, the Trump effect is muddying the waters.

In the meantime, low tier housing appears to be accelerating while high tier housing continues to moderately rise.  There are reports of high tier contraction in the Closed Access cities, and I don't really see any sign of expanding mortgage financing in the broader numbers, so while the high tier price trends seem ok, I don't see where the fuel for low tier pricing is coming from, especially since we seem to have come to a transition point between investor buying and owner-occupier buying.

A lot of mixed signals.  Still seems dicey to me, but I'm afraid I'm just watching opportunities pass me by.

PS:  Here are some comments from Scott Sumner and Matthew Yglesias.  I might be a little more pessimistic than them, because I think the Fed overestimates fiscal stimulative effects, so monetary offset is more than 1:1.  On the other hand, to the extent that the mixture of monetary and fiscal influences leads to more inflation but lower real growth, that might help to continue the grindingly slow recovery in housing and end up boosting real growth.

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