October 2020 Yield Curve Update

 The yield curve has taken a strong bullish move as a result of the election and the Covid-19 vaccine progress.  The long end of the Eurodollar curve is nearly back to the pre-Covid level.

The date of the first rate hike remains in mid-2021, but the escape velocity has increased significantly.  Forward inflation breakevens remain level at about 1.6%, which suggests that the recent improvement has been due to real shocks.  The Fed probably still has room for more traditional accommodation.

September 2020 Yield Curve Update

 The yield curve continues to slowly show optimism.  The long end of the curve continues to climb.  It's now back up above the yields of early April.  This suggests that the market foresees continued relatively strong recovery in employment and that the Fed is adequately providing liquidity.  Forward inflation expectations have leveled out below 2%, but they are basically as high as they were before the Covid-19 outbreak.  That's probably reasonably good news.  And, the expected date of the first rate hike is settling in around the June 2021 contract, which is pretty bullish.  The market seems to think recovery is in the works.

Both because there is an endemic lack of adequate supply and because of some of the demand responses to Covid-19, residential investment should be strong to help with a continuation of positive trends.  This suggests to me that if there is much of a pullback in stocks, it will be from an unforeseen negative real shock.

Getting the word out.

There have been a couple of great citations recently of my housing boom work.

As I mentioned recently, Mercatus published a paper that Scott Sumner and I had written.  Matthew Yglesias at vox.com cited it in a nice article about the need for more housing.

Also, Congress' Joint Economic Committee issued a new report on monetary policy that surprisingly pushes the envelope on new ideas. Stable Monetary Policy to Connect More Americans to Work

It was penned by Senior Economist Alan Cole.  The report cites Shut Out and supports the NGDP targeting policy that the Mercatus Center Monetary Policy group has been advocating for.

Here is Scott Sumner's reaction to it.  It's worth reading both Scott's reaction and the report itself.  It is very encouraging to see the building blocks being put in place for future improvements on these policies.

August 2020 Yield Curve

Inflation breakevens continue to rise, slowly.  After really flattening out last month, the yield curve perked up in August, somewhat, especially helped by recent Fed discussion about allowing for more catch-up inflation and a more of a symmetrical 2% inflation target.

The move up is a good sign, but higher would be better.  (Sorry, the graphs a bit of a mess.  Sept. 2 is the light blue line in the group of curves toward the bottom.)

The date of the first expected rate hike is displaying a good trend.  Last month, the expectation had moved all the way toward 2022.  Now, it's moved back to June 2021.  It looks like it might have some staying power.  Of course, the Fed communicates loose policy intentions by saying they are committed to keeping rates low for longer.  It is staggering to think such a useless communication policy is the norm, but it is what it is.  The better (more accommodating) they are the faster they will get to the first hike.

Housing Policy, Monetary Policy, and the Great Recession

Here's a link to a research paper the Mercatus Center has published by me and Scott Sumner.

Housing Policy, Monetary Policy, and the Great Recession

It's a combination of Scott's work on Federal Reserve policy and my work on the housing bust.  Here is our takeaway:

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Policymakers should not slow the economy in an attempt to prevent bubbles, which are not easy to identify in real time. Such efforts to reduce demand in 2007–08 were not only unnecessary but were also responsible for the reces­sion and financial crisis. 

Instead, US policymakers should adopt regulatory, credit, and monetary policies that can help stabilize the econ­omy, allowing the creation of an environment for healthy growth in living standards. Such an approach involves three components:

1. Reform zoning regulations in urban areas. This would allow for more construction of new housing, espe­cially in closed-access cities such as Boston, Los Angeles, New York City, and San Francisco, where con­strained growth is currently resulting in high housing prices. The United States could sustainably employ many more workers in home construction if restrictions on building were removed. 
2. Avoid a situation where lending regulations are most lax during booms and tightest during recessions. It was this sort of regulatory pattern that almost certainly exacerbated the severity of the Great Recession. 
3. Monetary policy should seek stable growth in nominal gross domestic product (NGDP). Rather than target­ing inflation and unemployment, policymakers should aim for a relatively stable rate of growth in NGDP, the dollar value of all goods and services produced within a nation’s borders. Attempts to use monetary policy to pop bubbles in individual asset markets such as real estate often end up destabilizing the overall economy. A stable NGDP growth rate, however, will provide an environment that is conducive to a stable labor market and a stable financial system.

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If you're interested, at the link there is a link with a pdf download.  We address a wide range of evidence, some of which I am certain you have not seen before.

Trends in Housing Supply

Here's a little sneak peak into some work I've been finishing up.   This graph shows the number of permits issued for single family homes and multi-unit projects (duplexes on up to high rise condos).  The measure is the number of units as a percentage of existing homes.  In other words, what is the gross percentage growth in the housing stock, due to single unit and multi unit building.  The black lines are the averages among all large metros.  The red lines are the averages among the "Closed Access" cities - New York City, Los Angeles, Boston, San Francisco, San Diego, and San Jose.

I find several interesting items to note here:

1) Of course, the Closed Access cities build single family homes at much lower rates than anywhere else.  Also, there was absolutely no supply response in the Closed Access cities in the single family market due to the subprime lending boom.  The rate of single family building was lower in 2005 than it had been in any year since 1996.  I have heard anecdotal defenses of the housing bust, claiming that even cities like LA had excess supply where single family homes were being built in the suburbs, where there wasn't really demand for them.  That idea is belied by the data.

2) However, as prices increased, there was a tremendous supply response in the Closed Access cities in multi-unit projects.  In spite of the horror stories of the local hoops one must jump through to build apartments, the Closed Access cities really are building many more apartments than they had before 2003.

3) Since 2004, in fact, the rate of multi-unit building in the Closed Access cities has matched the national average.  In the end, the regulatory obstacles create higher prices.  Potential residents push prices up until it is worth the trouble to build units.  The regulatory obstacles now are raising prices rather than pushing down new supply, relative to other cities.  This suggests that demand is inelastic.  Agglomeration effects, etc. are strong.  This is, in fact, bad news.  This suggests that the regulatory limits to multi-unit housing are more widespread than just the Closed Access cities.  As bad as the regulatory environment is in the Closed Access cities, other cities are not building multi-unit housing at a rate significantly higher than they are.

4) The deep cuts to mortgage lending since 2007 have cut into single family building in the Closed Access cities just as much as they have in other cities.  Building in the Closed Access cities has nearly recovered to pre-crisis levels, but that's all multi-unit.  In the 1970s and 1980s, it was common for multi-unit building to be double or triple what it is today.  To get anywhere close to that today would require a wholesale regulatory overhaul across the country.

Fortunately, the political center seems to be moving in that direction.  We have a long way to go.

I am finishing up a paper with much more detail on housing supply before the crisis, and another with much more detail on the influences on home prices.

July 2020 Yield Curve Update

The Fed is failing us.  It started out great.  The initial reaction to the pandemic was timely and forceful.  The yield curve on March 18 was signaling confidence.  But, since then, we have been slowly sinking into stagnation.  The long end of the Eurodollar curve is barely over 1% now.  It is true that forward inflation expectations have continued to slowly rise, though they are still well under 2%.

Here are two graphs of yields.  The first shows the Eurodollar curve at several points in time.  It is now at a new low.  The second shows the expected date of the bottom in short term yields.  The yield curve bottom is now settling in on March 2022.  The date is moving away from us over time, not toward us.  This was the pattern during QE1-3, when QEs were on, the date of the first rate increase would stabilize, but the Fed always cut the QEs off before we actually arrived at the date, and when they would stop the QEs, the date would move off into the future again.

When the yield curve inverted in 2019, the Fed reacted moderately well to it, and at least the expected date of the next rate hike was relatively stable, ranging around June 2021 for all of 2019.  Then, their aggressive moves in March actually briefly moved the date closer.  I thought that the pandemic might have actually kicked them into gear a bit to focus more on nominal economic recovery.  Briefly, in March, the expected first rate hike had moved as far as September - next month.  But that didn't last.

This is not a comment on all the emergency lending programs.  They simply should be buying a lot more Treasuries until nominal income or inflation expectations recover more.

A miracle homeownership boom!

According to the Census Bureau, homeownership shot up by 2.6% just this quarter!  Normally, that amount of change would take a decade or more.

Vacancies also declined sharply.

According to the estimate of total housing inventory, there were 4.8 million more homeowners in the second quarter than there were in the first quarter.  To put that in perspective, the National Association of Realtors estimates that there were a bit over a million homes sold in the second quarter.

The Census report on homeownership and vacancy includes a warning about changes in their methods of data collection due to the coronavirus.  It seems likely that a lot of renters did not respond to phone interview requests, and somewhere along the lines, the statistical methods for estimating total population went haywire, and we basically don't know anything about how homeownership and vacancies changed during the quarter.

There is a lot about the country we really don't know.  It is hard to know exactly how many people are in a real financial bind and what they are doing about it.  We are flying blind, which is why we need to err on the side of generosity in public safety net provisions right now, and do everything we can to reduce the contagion risks ASAP.

June 2020 Yield Curve Update

The yield curve remains at about the same place it was a month ago.

Since the mid-March peak of optimism after the initial reactions to COVID-19, yields have declined, which would suggest that the Fed could do more in terms of basic nominal stimulus.  But, the decline in long-term yields has been real.  Inflation expectations have inched upward, though tepidly.

I don't have an opinion about the various lending programs in place, but it seems like there is plenty of room for the Fed to simply buy Treasuries until inflation expectations move above 2%.  A steeper yield curve would be a good sign.

In the meantime, the low point of the inversion looks like it's moving ahead in time, which is not a good sign.  Along with a steeper yield curve, it would be nice to see market expectations of sooner increases in short term rates.  The Fed can't cure COVID-19, but it can minimize the costs and dislocations caused by nominal decreases in incomes.  There is no reason for the Fed to let the market expect the yield curve to be inverted until 2022, but we might be headed there.

That being said, the Fed has been more active than what I would have expected.  I appreciate the new direction.  They aren't creating nominal economic crises like they did back in 2008.  But, there are parallels, still.  In 2008, during the month after Lehman Brothers failed, when markets were being tossed to and fro, and intensive debates raged about bailouts, TARP, and all the rest, the Fed sat on a 2% Fed Funds target rate - a target rate that was so disastrously high they never really managed to hit it.  In the midst of all the debates about unconventional policy efforts, it seems that it didn't occur to anyone to do conventional monetary policy and lower the rate.

We have sort of a similar issue now, with all the special lending programs, all the kvetching online about who got it and who didn't, etc., and in the meantime, the Fed could be purchasing many more Treasuries than they currently are.

May 2020 Yield Curve Update

 The yield curve (using Eurodollar futures) has undergone a series of shifts with the coronavirus pandemic.  In the first graph, we can see that starting from the end of January, the whole curve shifted down by early March.  It shifted down more by March 10, as the extent of the pandemic became worse.  Then, it steepened over the next week as, across the US, cities, states, and citizens took action.

Then it shifted down again in late March as the pandemic worsened in the early weeks of the lockdown.  Then it steepened again over the course of April and May.

The result of these shifts is that short term rates are much lower than they were at the beginning of March but long term rates are about the same as they were.

I would say that we have encountered a pretty hairy real economic shock, but the Fed has done a decent job of countering that shock so that the nominal shock is lower than it could be.  (Five year inflation is still under 1%, so there is room for more, but obviously the Fed has been very active.)

The second chart here is an estimate of the first month when short term rates are expected to rise.  Before the pandemic, rates were not expected to bottom until September 2021, and that date was potentially moving out in time, just like it did after the GFC when the Fed would prematurely stop doing quantitative easing.

That was the main danger of the pre-COVID economy, that the Fed was pulling back on nominal growth just a little too much.  That, by itself, is unlikely to cause a crisis or an intense contraction, but it does put the economy in more danger of running into problems, especially, as the past 3 months have made clear, we never know what's around the corner.

The shock we did get was strong enough to kick the Fed into recovery mode, so I think the stock market has basically reacted to an exchange of risks.  We got a real shock, but now we are less likely to have whatever low-level monetary stagnation we were going to get otherwise.  If the expected future date of the first rate increase continues to push back to us in time (it's now at June 2021), then that might be evidence that the Fed has mitigated some of the real shock by moving into recovery mode.  Basically, this would create a deeper but shorter recession.

The next graph is my modified inversion measure.  Any spot below the trendlines is effectively yield curve inversion.  We are still technically inverted, but now the Fed has so many programs in place to provide liquidity there might be hope for recovery even if long-term yields remain low.  Understanding that is above my pay grade.  In either case, if 10 year yields can rise above, say, 1.5%, that would definitely be bullish.  Even moreso if the Fed misinterprets buoyant yields as some sort of headwind that calls for more stimulus.

In the meantime, it's a trader's market.  There are a lot of stocks still well below their previous highs and many stocks at all-time highs.  Their relative outcomes will depend on real developments.  A lot of people are talking about where the "stock market" is, but now really is a time where prices on individual stocks can present opportunities for acting on particular knowledge or simply for having the guts to take on potentially embarrassing positions that, nonetheless, have potential.