Monday, May 9, 2011
The 20 year Japanese bear market in real estate is making its way to the United States. Home prices in the U.S. are now in a double-dip and have gone
What if real estate prices remain the same for another decade? As I look at economic trends in our nation including the jobs we are adding, it is becoming more apparent that we may be entering a time when low wage jobs dominate and home prices remain sluggish for a decade moving forward. Why would this occur? No one has a crystal ball but looking at the Federal Reserve’squantitative easing program, growth of lower paying jobs, baby boomers retiring, and the massive amount of excess housing inventory we start to see why Japan’s post-bubble real estate market is very likely to occur in the United States. It is probably useful to mention that the Case-Shiller 20 City Index has already hit the rewind button to 2003 and many metro areas have already surpassed the lost decade mark in prices. This is the aftermath of a bubble. Prices cannot go back to previous peaks because those summits never reflected an economic reality that was sustainable. A chart comparing both Japan and U.S. housing markets would be useful here.
Will the U.S. have 20 years of stagnant home prices?
Source: Pragmatic Capitalism
This chart does a simple comparison of Osaka condo and Tokyo condo prices which does not reflect the entirety of the Japanese housing market. Yet the path seems very similar. Large areas with a real estate frenzy that hit high peaks and have struggled ever since. In fact, if we look at nationwide prices we realize that Japan has seen a 20 year bear market in real estate:
Japan urban land prices are back to levels last seen in the 1980s. You have to ask if there are parallels to our current condition. The first point we all have to agree on is that both economies had extraordinarily large real estate bubbles. For the United States the answer to this assumption is a big yes. We can run off a check list of how our real estate markets run similarities:
-Massive real estate bubble (check)
-Central bank bailing out banks (check)
-Bailed out banks keep bad real estate loans on their books at inflated values (check)
-Government taking on higher and higher levels of debt relative to GDP (check)
-Employment situation stabilizes with less secure labor force (check)
-Home prices remain stagnant (check)
Now the similarities are closely aligned in terms of banking policy. Our Federal Reserve followed a more aggressive path than Japan in bailing out our large banks. Yet all this did was make the too big to fail even bigger and exacerbated underlying issues in our economy. Four full years into the crisis and we are still dealing with a massive amount of shadow inventory. Remember the initial days when the talk was about working through the backlog of properties in a clean and efficient manner? Whatever happened to that? Banks operate through balance sheet accounting and it has made more sense to pretend the shadow inventory has somehow maintained peak prices while chasing other financial bubbles in other sectors. Not a hard way to make money when you can borrow from the Fed for virtually zero percent.
Japan and U.S. see real estate as poor investments
Our earlier assumption about the double-dip real estate recessions has now materialized through home price measures:
The above chart may not seem like a big deal to some but keep in mind the United States had never witnessed a year over year drop in nationwide home prices since the Great Depression. Not only has that been surpassed but home prices are now back to levels last seen 8 years ago. The lost decade is now nipping at our heels but what about two lost decades like Japan?
Source: Debt Watch Blog
For some this may seem outrageous even to consider. The way I see it is that Japan was quickly catching up U.S. GDP in 1995 and many thought that it would at some point surpass our GDP. This was solidly the number two global economy for many years until China took that place last year. Yet the real estate bust has really been a drag on the economy for years moving forward:
Why has real estate been such a drag on the overall Japanese economy? First, Japan’s unemployment rate stabilized after these bubbles burst but it shifted to a large temporary or contract based employment economy. One third of Japanese workers operate under this new world. Relatively low security with employers and this has spiraled into lower income and money to finance home purchases. The fact that the U.S. has such a large number of part-time workers and many of the new jobs being added are coming in lower paying sectors signifies that our economy is not supportive of the reasons that gave us solid home prices for many decades. I think this is a key point many in the real estate industry fail to emphasize. How can home prices remain inflated if incomes are moving lower?
The question of affordability has always been at the center of this debate. Yet with government mortgages being the only option and banks now actually having to verify income Americans can only afford so much home when the gimmicks are removed like layers on an onion. This is why the double-dip is now fully here:
How much further will home prices fall? It can be that nationwide they fall only slightly more but in the end a lost decade is in the books. Two lost decades might be a real possibility given our demographic trends especially with baby boomers moving forward.
Massive inflation or stagnation moving forward?
One would think that with all the Bank of Japan bailout measures for the banks and government spending that inflation would run rampant in the Japanese economy. That was never the case:
It is interesting to note that most of our inflation is coming from items ex-housing. As I have discussed the BLS does an interesting measure of home prices via the owner’s equivalent of rent. The reality is the above year over year changes in inflation in the U.S. are not coming from home prices.
Watching some of the global news I was seeing many young Japanese workers, some in their late 20s or early 30s, already resigned that they would never buy a home. They asked a young professional if he ever planned to buy a home and his response was (paraphrased):
“I don’t ever plan to buy. I saw my mother and father lose their marriage over trying to pay for the home payment for years. That was many of the big fights in our family. In the end we lost the home and I feel I lost my family. Why would I put pressure on myself for something like that?”
The millions of people that have lost their home and will lose their home are probably in households with children in many cases. Some may be in college and looking to buy in ten years. The notion that housing is always a great investment runs counter to what they saw in their lives. Will they even want to buy as many baby boomers put their larger homes on the market to downsize? Will they clear out the shadow inventory glut? Now I’m not sure how things are in Japan but many of our young households here are now coming out with massive amounts of student loan debt.
It was interesting to see the Wall Street Journal coming out recently with an article stating that the Class of 2011 will be the most indebted ever:
“(WSJ) The Class of 2011 will graduate this spring from America’s colleges and universities with a dubious distinction: the most indebted ever.
Even as the average U.S. household pares down its debts, the new degree-holders who represent the country’s best hope for future prosperity are headed in the opposite direction. With tuition rising at an annual rate of about 5% and cash-strapped parents less able to help, the mean student-debt burden at graduation will reach nearly $18,000 this year, estimates Mark Kantrowitz, publisher of student-aid websites Fastweb.comand FinAid.org. Together with loans parents take on to finance their children’s college educations — loans that the students often pay themselves – the estimate comes to about $22,900. That’s 8% more than last year and, in inflation-adjusted terms, 47% more than a decade ago.”
Lower incomes, more debt, and less job security. What this translated to in Japan was stagnant homeprices for 20 full years. We are nearing our 10 year bear market anniversary in real estate so another 10 is not impossible. What can change this? Higher median household incomes across the nation but at a time when gas costs $4 a gallon, grocery prices are increasing, college tuition is in a bubble, and the financial system operates with no reform and exploits the bubble of the day, it is hard to see why Americans would be pushing home prices higher.
NIA expects 'College Conspiracy' to take college education by storm and expose the facts and truth about tuition inflation to prospective college students. Almost everybody applying to college has heard the oft-repeated statistic that Americans with college degrees earn $1 million more in lifetime income than high school graduates without a degree. This is one of those statistics that gets repeated so many times that just about everybody accepts it as fact, but nobody actually does the research to confirm whether or not it is true. 'College Conspiracy' will prove once and for all if indeed this so-called statistic is true or just a myth.
If 70.1% of high school graduates enroll in a college or university, how does a college degree give you an advantage over the rest of the population? Back in the early 1960s, Americans didn't need to go to college. We were a creditor nation with a strong manufacturing base. With an unemployment rate of only 5%, jobs were available to almost everybody. Less than 50% of American high school graduates enrolled into college. For those who did attend college and graduate with a degree, it was actually something special that made you stand out from the rest of the field, because not everybody had one.
American college tuition inflation has been out of control for the past decade. During the financial crisis of late-2008/early-2009, almost all goods and services in America at least temporarily declined in price. The only service in America that continued to rise in price throughout the financial crisis, besides health care, was college education. Despite real unemployment in America reaching 22%, students were brainwashed into believing that if they were lucky enough to be blessed with the privilege to get half a million dollars into debt to obtain a college degree, they will be on a path to riches and have a guaranteed successful career; whereas those who don't attend college are destined to be failures in life.
The current college education bubble is one of the largest bubbles in U.S. history. The college bubble has been fueled by the U.S. government's willingness to give out cheap and easy student loans to anybody who applied for them, regardless of if they will ever have the ability to pay the loans back. Student loan debt in America is now larger than credit card debt, but unlike credit card debt, student loan debt can't be discharged in bankruptcy.
During the 1970s, college students were able to afford their own college tuition without getting into any debt, simply by working a part-time job year round or by working a full-time job during the summer. Not only that, but most college students were also able to afford their own car and a small apartment. However, since 1970, Americans have experienced a 50% decline in their standard of living due to the Federal Reserve's dangerous and destructive monetary policies. You never heard of parents setting up college savings accounts for their children 40 years ago, but thanks to the Federal Reserve, this has become the norm.
The biggest competitive threat to Wal-Mart today in terms of market cap ($192 billion) is not Target ($35 billion) like you might think, but is actually Amazon.com ($89 billion). Wal-Mart is able to offer the lowest prices out of all brick and mortar retailers, because of the size and scope of the company, which allows them to be profitable even at extremely low gross margins. However, while Wal-Mart's stock price is only up 16% from where it was exactly 5 years ago, Amazon.com's stock price is up 470% during this same time period.
Amazon.com's stock price has risen by a 29 times higher percentage than Wal-Mart due to the fact that they sell their products over the Internet with substantially less overhead costs. NIA believes that the future of college education is over the Internet and that Americans in the future will be able to receive a better quality education from the best professors from all around the world at only a fraction of the cost of a traditional brick and mortar college education.
For the vast majority of college courses, there is absolutely nothing that students can learn in a huge multi-million dollar lecture hall with hundreds of other students that they can't learn at home listening to that same professor on a computer. The only reason online colleges haven't taken off yet in America and still have less than a 1% market share of U.S. higher education is because America has a college-industrial complex that cares only about profits and not educating students. The people who control the system simply don't want the system to change, because they are making way too much money by turning American students into indentured servants.
Back in the 1980s when Americans graduated high school, they would get hundreds of thousands of dollars into debt to buy a house. Today, millions of Americans have mortgage-sized debts, but still live with their parents. All they have is a piece of paper called a college degree, that is rapidly declining in value even faster than tuitions are skyrocketing in price.
'College Conspiracy' was made possible by the personal stories that were submitted to us by thousands of NIA members. NIA's staff spent the past six months traveling across the country, interviewing our country's top expert guests in nine different states. Please tell all of you family members and friends to become members of NIA for free immediately so that they along with you can be among the first to see 'College Conspiracy'.
Here is a log scale ratio price chart of $GYX:$GOLD since 2003:
The last major trend line break was a warning signal for the end of the last cyclical general equity bull market. Will history repeat? I believe it will but I have no interest in shorting the stock market at this time. I may after a confirmed major trend line break in general equity indices and a subsequent relief rally higher, but not now.
Pricing things in Gold is an important concept for those who hold physical metal. It is shocking to see how much the Dow Jones and housing prices have declined in Gold terms since their peak. The nominal declines are much less severe. This is why printing is the best way out for governments around the world. It worked in the 1970s and it might just work again. The problem for the U.S. is that its problems are much bigger this time around than in the 1970s, so that the amount of monetary inflation needed to combat the ongoing economic problems is much greater.
If the Dow Jones Industrial Average is at the 10,000 level in 10 years but a loaf of bread costs $15 at that time, many people will be fooled into thinking things aren't that bad. The boiling frog analogy is apropos here. Private debt is being extinguished by putting it on the public books! This is high treason right in front of our eyes, but it will continue. Consider Fannie Mae and Freddie Mac needing $259 billion from taxpayers to bail them out. Now this $259 billion is a current number and it will go higher before the real estate bust is over - count on it since the government now backs 85% or so of all mortgages in the United States.
When you transfer all that bad debt to the government balance sheet, you weaken the currency. U.S. Dollar-centric deflationists assume that the laws will be followed and that what is reasonable and appropriate will be at least a minor consideration. These assumptions are erroneous, as recent policy decisions and policymaker law breaking have shown. What if almost all the bad debt created and/or held by "the friends of Angelo" [i.e. Angelo Mozillo of Countrywide], by which I mean to sarcastically refer to the major financial corporations of America, is placed on the government balance sheet?
Gold is a buy at current levels. The current monetary system will be replaced before this secular equities bear market is over, whether in 5 years or 15. The best way for the average person to protect their financial wealth is to buy and hold physical Gold outside the banking system. Other precious metals should also do well and may do even better, but they carry a higher risk. The longer the chaotic policy response to unavoidable economic outcomes continues, the higher the chance that the Dow to Gold ratio will fall below 1 this cycle and the higher the likelihood that this ratio will bottom with Gold in 5 digit territory.
Gold Long-term Long Way From a Bearish Reversal
The long term P&F chart is no help here in trying to guess what next for gold price. It is still a long way from a bearish reversal and really requires a couple of direction reversals to give any reasonable message. For now it is still bullish although dropping drastically, as could be expected.
Despite the plunge during the week my long term indicators are still in comfortable positive territory and nowhere near giving a reversal signal. The week’s collapse in gold price is so far more of an intermediate and short term problem and only an annoyance from the long term perspective.
Gold closed Friday on the up side but nowhere near recovering. However, it is still above its positive sloping moving average line. The long term momentum indicator is still comfortably above its neutral line in the positive zone. However, the one minor negative is the indicator being below its negative sloping trigger line. The volume indicator is still in a positive trend from the long term perspective and remains above its positive trigger line. For now the long term rating remains BULLISH.
All is not yet lost. The intermediate term remained positive during the plunge with the gold price just touching the positive sloping intermediate term moving average line on Thursday resulting in that mild bounce on Friday. The intermediate term momentum indicator remained in its positive zone although it did go through quite a drop and ended the week below its negative trigger line. As for the volume indicator, it is still trending positively and closed the week slightly above its positive trigger line. So, all in all, the intermediate term rating remains BULLISH. The short term moving average line is still some distance above the intermediate term line confirming this bull.
Well that was quick. No sooner were the FAN lines shown last week than that blow-off third FAN trend line was broken and the plunge was upon us. If one looks closely there were a couple of warnings the day or so before the plunge. The gold price made new highs on Monday BUT closed below its opening price suggesting some exhaustion in the move.
The Stochastic Oscillator was anemic and just couldn’t match the new high in gold price suggesting here a serious weakness in the move. The next day gold closed below the third FAN trend line and that was it. Very quickly the plunge reached that first FAN trend line and Friday we had a little bounce. Now what? I would not be surprised if gold remained trading in that area between the first and second FAN trend lines for a while, but who knows? From here anything can happen. I would not be too inclined to guess a quick recovery until the stocks perk up. As often suggested here, the stocks are very often a leading indicator to what might be expected from the commodity. So we watch both, just in case the stocks do not give us that advance notice.
As for where we are from the short term perspective, well, gold is trading below its negative short term moving average line. The momentum indicator was in its negative zone but closed on Friday just a hair above its neutral line. It remains below its negative trigger line. As for the daily volume activity, that has been mostly on the down side this past week. All in all the short term rating, at the Friday close, is BEARISH. The very short term moving average line has just confirmed that rating by closing on Friday just very slightly below the short term moving average line.
As for the immediate direction of least resistance, that is a difficult guess when one does not know what is happening on the world stage. The global politics have a great effect on the immediate direction of gold. I would think that the short term is still slanted towards the down side but we do have a couple of possible hints that a rally of some sort may not be long in coming. The Stochastic Oscillator has entered its oversold zone and a reversal could come any day although there is still no definite sign of one yet, just a hint of possible turning in its very early stage. The price itself perked up on Friday and may be headed towards that second FAN trend line, which might be considered as a resistance line now. I’ll go with the lateral as the best guess for the immediate direction although hoping for more upside.
As one might expect with its recent superior performance, when the reaction came silver took a more severe beating than gold. We had all 5 days this past week of silver downside action. Friday’s action, however, closed above its opening price which might suggest that we might be in for a rally, even if of short term duration. As with gold the plunge in silver price has caused a great deal of damage and one should not expect an immediate recovery, they happen but don’t expect it. The Stochastic Oscillator is in its oversold zone and is starting to give us a hint that a turning process may be starting, so stay tuned. Watch the daily action on any of a variety of charting web sites if you are not downloading the daily data into your own computer.
While gold has just touched its intermediate term moving average line silver is far below its intermediate term line. In fact it is just slightly above its long term moving average line. I use a weighted moving average which is somewhat more aggressive than is the simple moving average. For those using the simple moving average line silver is still some distance above that long term line.
While the technical indicators are very much the same as for gold, the intermediate term ones are somewhat different. On the intermediate term silver is well below its negative moving average line. The momentum indicator has entered its negative zone and did not recover like gold on Friday. It remains below its negative trigger line. As one might expect the intermediate term volume indicator is coming down sharply and has ended the week just very slightly above its still positive trigger line. Putting it all together the intermediate term rating is now BEARISH. The other two time periods are similar to gold, BULLISH on the long term and BEARISH on the short term.
PRECIOUS METAL STOCKS
Well it sure looks like the Merv’s Penny Arcade Index was right. It started its decline several weeks back and was a warning of an upcoming reversal in the other Indices, which basically occurred this past week. Most of the North American Indices are sitting on top of support levels while the various Merv’s Indices (other than the Penny Arcade) are still some distance from their supports. The trend is, however, towards lower levels for a while. The action this past week took most stocks into negative territory. There were only 7% of the universe of 160 that closed the week on the up side. 93% of the universe stocks closed lower. That will take a little while to recover. Another way of looking at what occurred in the market is looking at how many stocks reversed their bullish rating to bearish ones. On the intermediate term a full 49 stocks reversed their rating. This is more than I ever recall seeing during a one week period. Let’s just say it will take some doing to recover from this past week, but I have no doubt that we will eventually recover and see new highs in the various Indices in the not too distant future. In the mean time there might still be more troubled waters ahead before the bottom.
Merv’s Precious Metals Indices Table
Well, that’s it for this week. Comments are always welcome and should be addressed to email@example.com.
By Merv Burak, CMT
Britain isn’t cutting its structural deficit by enough or doing it quickly enough and may need a bailout from its European partners, investor Jim Rogers told CNBC.
But UK-based analysts disputed this view, saying the austerity measures were enough.
Rogers said the UK coalition government needed to go further in order to avoid financial catastrophe.
“They [the government] are not doing it. They are saying they are doing it but they are not. They are saving £1 billion ($1.6 billion) here or there but they are not doing what they really need to and I’m not sure the government would survive the kind of pain that is really required," he said.
“How can the UK ever repay the debt that is continually rising? The UK will need a bailout soon. You have the advantage that your debt is longer term but let’s assume the government keep to these austerity plans or really put them in place people will start to complain," Rogers explained.
“The government will begin to lose by-elections and the government could fall, then what?”
His comments came as the British electorate went to the polls for the first time since last year’s general election, which resulted in a coalition government of the Conservative party and Liberal Democrats and a program of public spending cuts which began in earnest in March.
Elections were being held for the devolved national assemblies of Scotland, Wales and Northern Ireland as well as over 200 local councils.
A national referendum to decide on whether to change the voting system from its current first past the post, (one person, one vote) to a form of proportional representation called the Alternative Vote, as used in Australia, also took place on Thursday.
The referendum was the first national referendum since 1973 when the UK voted on whether to remain a member of the European Economic Community (EEC).
It was one of the Conservative party’s concessions to their Liberal Democrat partners during last year’s coalition negotiations following the general election.
However, campaigning ahead of the referendum has become embittered with members of the cabinet including Lib Dem energy secretary Chris Huhne and his colleague business secretary Vince Cable becoming increasingly vociferous in their complaints about the behaviour of their Conservative cabinet colleagues.
The Liberal Democrats were expected to not only lose the vote on reform of the UK’s electoral system on Friday but also several key City councils in their power base in the north of England, such as Sheffield, Hull, Manchester and Stockport.
The results will mean that Deputy Prime Minister and Lib Dem leader Nick Clegg will come under further pressure to put some political distance between his party and the Conservatives.
The elections were also the first real test of support for the coalition government‘s austerity plans - already the deepest cuts in public spending since the end of the Second World War.
Two senior economists said Rogers showed a lack to understanding of the UK economy and defended the government’s current austerity plans.
“I would flatly reject the idea that austerity measures are not going far enough," Peter Dixon, economist at Commerzbank said.
"The fact of the matter is we have fiscal tightening equivalent to five percent of GDP at a time when the economic recovery is very weak."
“In terms of a bailout that shows a lack of understanding of the UK economy The UK has control of its own currency, it’s not part of the euro, so debt restructuring is not going to happen,” he added.
Cuts 'Incredibly Tough'
George Buckley, chief UK economist at Deutsche Bank, also defended the government’s austerity proposals.
“That [view] is going to one end of the spectrum," Buckley said.
"The true answer is that if you look at how much the government is cutting it’s comparable to around 8.5 percent of the structural deficit which is much tougher than we saw the last time there were cuts of this nature."
“Compared to the 1980s and 1990s which saw cuts of 7 to 7.5 percent over a far longer period of time that’s incredibly tough,” he added.
Both men warned that cutting spending further would stifle any kind of economic growth, which they said would remain weak for up to two years as household consumption contracted as a direct result of the government’s austerity plans.
Dixon added that he did not see the stability of the coalition government as being a concern in terms of either investor confidence or the wider UK economy in general.
But he warned things could “deteriorate fairly rapidly.”
“Nick Clegg and the rest of the Lib Dem MPs are perceived to have sold out and are seen as following a Tory line. But bear in mind that these MPs are likely to be in parliament for the next four years,” he said.
“I think we will see the coalition trying to continue with its current plan for a couple more years. But if in 2013 the economy is not doing well, and unemployment is up, and people are feeling the pain, then that’s when the Lib Dem MPs might get concerned that they are going to lose big at the next election and that’s when the coalition might well come under the kind of pressure that could led to a split,” Dixon added.
And like clockwork, the expect avalanche of economic downgrades greenlighted by Jan Hatzius begins. Heading up the lemming crew, as always, is Morgan Stanley's David Greenlaw. "We are adjusting our GDP growth forecast lower for the third time this year. We now look for +3.3% GDP growth over the four quarters of 2011 (versus +3.6% in our April update). Essentially, this puts us back to where we were in early December – before policymakers enacted a package of tax cuts aimed at stimulating the economy." In other news David, how do you spell roundtrip (and is a refund due)? Or "hockeystick?" Or how about an imminent push for more QEasing once the inflationary "shock" is forgotten (unless Saudi Arabia falls to the tsunami of "spooks on the ground" in which case all bets are off), just in case the virtuous cycle doesn't quite kick in, in this 3rd, and soon to be failed, attempt to jump start the economy. In other news, we can't wait to hear what validation LaVorgna, who is always at the very end of the lemming bus, comes up with to justify his feverish enthusiasm over the economy, which once again proves to be worth the amount of money DB's customers pay the firm's sales coverage to bet against them.
Full note from Morgan Stanley:
Another downgrade to US growth. We are adjusting our GDP growth forecast lower for the third time this year. We now look for +3.3% GDP growth over the four quarters of 2011 (versus +3.6% in our April update). Essentially, this puts us back to where we were in early December – before policymakers enacted a package of tax cuts aimed at stimulating the economy.
The logic behind this round trip in the forecast is fairly straightforward. The payroll tax cut enacted in December was worth a little more than $100 billion of stimulus for 2011. However, gasoline prices started off the year at $3/gallon and now stand at about $4/gallon. A good rule of thumb is that every $1/gallon change in gasoline prices subtracts about $120 billion from discretionary spending power. Since the elevation in gasoline has been largely exogenous (unrelated to internal demand forces) and since the personal savings rate is expected to be relatively steady, the move in gasoline just about fully offsets the impact of the payroll tax reduction.
Energy is still the big swing factor. To be sure, there are plenty of crosscurrents in energy markets at present. And, if the collapse in prices seen over the past couple of trading sessions is sustained, this would provide some meaningful support to the consumer.
Sustaining job growth is key. Crosscurrents are also evident in the labor market. We continue to believe that the US economy is currently in the midst of a transition from a recovery driven by a short-term surge in productivity growth to a more mature expansion sustained by job creation and associated income gains. Thus, it is critical that the recent acceleration in employment growth be sustained. While the latest results from the establishment survey were quite encouraging (+244,000 for April together with 46,000 of combined upward revisions to February/March), the household survey was less impressive and jobless claims have been drifting higher. We expect to see continued employment gains ahead – although perhaps not quite as strong as seen in recent months.
Stronger performance over the balance of 2011.
Otherwise, the key sources of upside for the US economy going forward from here are expected to be: 1) an eventual pickup in motor vehicle output, 2) ongoing momentum in capital spending, 3) significantly better performance from net exports, and 4) a rebound in defense outlays.
Keep an eye on core inflation. From our standpoint, the inflation story has been getting overlooked to some extent in recent months. In fact, we believe that inflation represents a far more important policy driver than the growth story at this point. Since troughing in October, the core CPI has moved from +0.6% year/year to +1.2% year/year. Most importantly, we don’t see anything that is likely to derail this trend in the months ahead. In particular, we have been emphasizing the fact that a significant tightening in rental market conditions across the US is putting a good deal of upward pressure on shelter costs. In fact, the story that we described in our December 22 note, “Have We Seen a Bottom in Core Inflation?” has been playing out according to script. Moreover, anecdotal information – including recent comments by the CEO’s of Wal-Mart and Kimberly-Clark – suggest that consumer goods prices will be on the rise in coming months.
CPI vs. PCE. Admittedly, the Fed likes to emphasize core PCE, which has been somewhat better behaved – moving up to +0.9% in March versus a trough of +0.7% back in December. However, the combination of developing fundamentals and base effects suggests that the year/year readings for core PCE will be trending sharply higher going forward. Indeed, we suspect that core PCE will reach +1.5% by October.
Exit ramp ahead. If you’re betting on a “Fed on hold” scenario for the rest of 2011 (“on hold” meaning no change in statement language, no change in MBS reinvestment policy, no reserve draining operations – and no rate hikes!), then you appear to be betting on a scenario in which the Fed ignores a sharp run-up in core inflation – to a rate that just about matches their long-run target. Moreover, you are also betting that despite the combination of such a huge move in core inflation and a complacent Fed, that inflation expectations will somehow remain well anchored. This seems farfetched. A bet on a “Fed on hold” scenario is really a bet that the recent trend in core inflation will dissipate – despite fairly widespread empirical and anecdotal evidence to the contrary.
Sequencing intact. The bottom line is that the exit sequencing timetable that we have been highlighting for a while still seems quite reasonable. We continue to look for the Fed to stop buying in June, stop reinvesting in August or September, start draining sometime in Q4, and hike the interest rate on reserves (IOR) in early 2012.
And summarizing it all (and more downgrades to come from here on out):
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|Date||Time (ET)||Statistic||For||Actual||Briefing Forecast||Market Expects||Prior||Revised From|
|May 10||8:30 AM||Export Prices ex-ag.||Apr||-||NA||NA||1.3%||-|
|May 10||8:30 AM||Import Prices ex-oil||Apr||-||NA||NA||0.6%||-|
|May 10||10:00 AM||Wholesale Inventories||Mar||-||0.9%||1.0%||1.0%||-|
|May 11||7:00 AM||MBA Mortgage Index||05/06||-||NA||NA||+4%||-|
|May 11||8:30 AM||Trade Balance||Mar||-||-$45.0B||-$47.8B||-$45.8B||-|
|May 11||10:30 AM||Crude Inventories||05/07||-||NA||NA||3.421M||-|
|May 11||2:00 PM||Treasury Budget||Apr||-||NA||NA||$82.7B||-|
|May 12||8:30 AM||Initial Claims||05/07||-||400K||423K||474K||-|
|May 12||8:30 AM||Continuing Claims||04/30||-||3700K||3700K||3733K||-|
|May 12||8:30 AM||PPI||Apr||-||0.5%||0.5%||0.7%||-|
|May 12||8:30 AM||Core PPI||Apr||-||0.1%||0.2%||0.3%||-|
|May 12||8:30 AM||Retail Sales||Apr||-||1.0%||0.6%||0.4%||-|
|May 12||8:30 AM||Retail Sales ex-auto||Apr||-||1.0%||0.5%||0.8%||-|
|May 12||10:00 AM||Business Inventories||Mar||-||1.0%||0.9%||0.5%||-|
|May 13||8:30 AM||CPI||Apr||-||0.3%||0.4%||0.5%||-|
|May 13||8:30 AM||Core CPI||Apr||-||0.1%||0.1%||0.1%||-|
|May 13||9:55 AM||Mich Sentiment||May||-||70.5||69.8||69.8||-|