Monday, October 21, 2019

September 2019 CPI Inflation and Yield Curve Updates

Sorry, I have been a little slow posting this month's update. This month was a return to the longer-term form. Shelter inflation moved up to 3.5% and non-shelter core CPI inflation moved down to 1.5%. Not much to add. I continue to think that the slower the Fed is to lower short term rates, the lower they will eventually go. I still think the yield curve is effectively inverted because the zero lower bound should bias long term yields higher. Normally, one might suspect that real estate and residential investment are important factors in the inverted yield curve. I would speculate that inverted yield curves lead recessions because they are signs of disequilibrium. Long term yields can't go as low as they need to. And one reason is that in order for yields in real estate to decline, prices need to rise, but rising prices require expanding money and credit. A similar point could be made with bonds. Cash is required to bid bond prices higher. But, the oddity with this cycle is that real estate borrowing has been repressed during the expansion. A loosening of regulatory pressure would probably release credit into low tier housing markets, raising prices, and triggering residential investment. Leading cyclical indicators in real estate will probably be most useful in high tier markets this cycle because those markets have not faced such unusual regulatory obstacles to funding. And, as AEI housing measures show, for instance, high tier prices have leveled off and inventories of homes for sale have grown.

I'm not sure what to expect other than continuing low long term yields, though.   Equity risk premiums are already at high levels.  Stocks could dip from declining growth expectations, but I'm not sure that we should expect much of a dip in equity prices.

Because homebuilders are both a defensive and a speculative position from here, they might offer some opportunities.  Hovnanian (HOV) was so low this summer that it received a warning from the NYSE that it might be delisted.  It has recovered sharply from those lows and makes an interesting position to follow as a reflection of the potential for pent up demand to emerge for new homes.  Increases in revenues should have a magnified effect on their market capitalization.  There was a recent paper that made a good statistical case that market concentration in homebuilding was holding back housing starts and pushing prices higher.  The executives at Hovnanian must have had a laugh about that, as, a decade after the crash they are still working to get revenues high enough to bring their financial and operational leverage back to more sustainable levels.

Otherwise, among equities, I think we're more in a period of keeping dry powder ready than we are in a period of excessive downside risk.  In spite of low yields, a bond position probably still isn't the worst position to have in the world, tactically, although they don't offer much benefit as a long term portfolio allocation.


  1. Shelter inflation moved up to 3.5% and non-shelter core CPI inflation moved down to 1.5%---Kevin E.

    Every month, Kevin Erdmann posts something similar to the above. And eight times a year the Federal Reserve Board issues its Beige Book full of nearly hysterical commentary on "worker shortages" but nary a word on "housing shortages."

    For some reason, policymakers and macroeconomists cannot think in terms of radically increasing housing supply. In Hong Kong the leadership recently suggested easing mortgage-underwriting standards. That is fine and may help a minor amount. My conclusion is that the property-financial class has too large stake in maintaining property values, to allow an increase in supply.

    I wonder what the trade dispute with China costs, in terms of the American consumer per capita per year, if anything. I think if you buy a washing machine, you might actually take a whack, perhaps $100.

    The typical consumer along the West Coast might be out $500 to $1,000 every month in additional rental expenses, due to property zoning and other supply-suffocating rules.

    1. Oh, it's not just the consumer on the coast. The real damage for the economy is in the people who didn't move to the coast, because of those missing houses.

  2. The commies know how to do it....

    "China Economy
    Shenzhen turning its back on Hong Kong property model in favour of affordable public housing
    The southern city is home to technology firms including Tencent and DJI, but rising prices caused by private land sales have made it one of China’s most expensive cities
    A new government plan will cap the price of land sold for subsidised housing at 30 to 40 per cent of the benchmark rate as it seeks to build 1 million units by 2035"



    A million units.

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