Why 2006 won't be like 1995
The 1995 soft landing meme gets a thorough going over in Greg Ip's column today: Why Fed Might Keep Rates on Hold Longer Today Than It Did in 1995, from a monetary policy perspective:
"Investors looking for a road map to the Federal Reserve's next moves on interest rates often look to 1995.
At the time, the Fed had raised interest rates steadily after a long period of unusually low rates. With the U.S. economy slowing, it paused for five months and then started cutting rates.
Many investors have been looking for that cycle to repeat itself and expect the Fed, which last raised interest rates in June, to begin cutting rates at some point in the next few months.
This year differs from 1995 in ways that suggest the Fed could stay on hold longer. One is that interest rates are lower now than back then. Another is that Fed officials' tolerance for inflation is quite different today."
Whenever I see a comparison between now and 1995, I am compelled to mention the following differentiating factors:
1) We were in the middle of an 18 year Bull market (versus being 5 years out from a horrendous tech crash, with the Nasdaq down 78%)
2) Post 1987 crash, the Fed cut rates, and real estate responded.By 1994/95, that cycle was long over.
3) Housing was only a minor sector of that economic cycle, versus the 2002-2006 version. As RE, and numerous rust belt industries were fading, there were plenty of other sectors to take its place:
-Wireless buildout;
-Internet ramp up;
-PC upgrade cycle
-SemiConductors and CPUs (286/386/486/586)
-Windows 95These are all more mature industries today.
4) No other sectors in today's economy are parallel to the short list above to take over for Residential Real Estate. Candidates include: Stem cell research, alternative energy, nanotechnology; even Commercial R/E is a third the size of Residential.
Lastly, consider the monetary conditions now versus then:
"A recession and weak expansion in the early 1990s helped nudge inflation lower, and "pre-emptive" rate increases in 1994-95 kept it from rising again. Accelerating productivity growth in the late 1990s, which enabled the economy to grow rapidly with less strain on existing capital and labor, nudged inflation lower still. Mr. Greenspan later declared that price stability had been achieved by mid-2003, when core inflation was between 1% and 1.5%. Core inflation has since risen to 2.9%, according to last week's report on September's consumer-price index; it's a bit lower using the Fed's preferred-price index. Though the Fed has no official target for inflation, Mr. Bernanke and many of his colleagues have often suggested a ceiling of about 2%, and all agree today's rate is too high."
The exercise gives the entire soft landing thesis a splash of cold water . . .
>
Source:
Why Fed Might Keep Rates on Hold Longer Today Than It Did in 1995
GREG IP
October 23, 2006; Page A2
http://online.wsj.com/article/SB116155511199600220.html
Monday, October 23, 2006 | 07:19 AM | Permalink
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Comments
To your shopping list of different factors this time around you might want to consider oil prices - weren't they around $10/barrel vs a likely floor of $50 on growing BRIC demands this time around ? And trade imbalances were likewise not so pronounced thruout the 90s. They were slightly negative and not deteriorating thruout the 90s but since the accession of China to the WTO in '01 they've been huge, increasing and accelerating. The resulting foreign-held dollar reserves imply either maintaining higher rates to support the $. Or a huge re-adjustment in currency holdings on the part of China, et.al. which could trigger a major downturn in the US economy.
Posted by: dblwyo | Oct 23, 2006 8:42:14 AM
the other side of the question is what would cause growth to reaccelerate after the slowdown.
We have had two soft landings, 1967 and 1995.
In 1967 guns and butter pulled us out.
In 1995 the high tech capital spending boom did the job.
So what would work this time?
Maybe the stimulous from a collapse of the dollar?
Posted by: spencer | Oct 23, 2006 8:59:37 AM
What was the housing market like in 1995?
That might be a critical difference.
Posted by: ari5000 | Oct 23, 2006 9:14:11 AM
In 1995 housing was coming out of a big downturn that had started in 1987 (after the Stock crash).
Today we are at just the beginning of what could be the biggest housing collapse since the Great Depression.
I think there's a bit of a difference.
~~~~
BR Ed, I recall after the 87 crash and the fed cut, we had a nice housing spurt for 2 years -- in NYC, there had been a massive condo/coop conversion from rentals in the 80s, and that post crash boomlet was probably the last spurt.
Posted by: edhopper | Oct 23, 2006 9:30:15 AM
I've been thinking along the same lines as spencer. If you let, or even help, the dollar to fall 15-20%, you've given a big boast to industrial and other exporters, like GE.
The inflationary impact on imports could be big. But let's face it, the easiest short-term escape from this situation is high inflation. If inflation were at 8% and home prices fell 5% in real terms, they still would be up in nominal terms, and that's what counts most as far as MEWs, defaults, etc., go.
Posted by: Bob_in_ma | Oct 23, 2006 9:33:02 AM
Decent Bloomberg story this a.m. on the ABX mortgage credit default index spiking 30% since beginning of August. According to the story, the ABX index, created by Markit Group Ltd., a London-based firm, measures prices of CDS based on the $565 billion MBS secured by subprime mortgages and home-equity loans.
Posted by: Vega | Oct 23, 2006 9:55:32 AM
Link to the Bloomber ABX article mentioned above:
Housing Slump in U.S. Poised to Worsen, Derivatives Trades Show
Posted by: anon | Oct 23, 2006 10:17:54 AM
that bloomberg article suggests to me that mortgage rates are going up regardless of what the fed does
Posted by: j d ess | Oct 23, 2006 10:31:40 AM
the wussell is wippin! wohoooo, when will the party end. not sure but whoever is jacking this thing up is doing fine by me. go with the flow until it changes then go with it again.
Posted by: MktManipulation | Oct 23, 2006 10:46:22 AM
spencer, the cheaper dollar --meaning more competitive US exports, was met by the BoJ in the past, yes? Is that move likely to be repeated?
The budding Chinese consumer is the new stimulous but how cheap does the dollar have to go before American goods become attractive?
Posted by: calmo | Oct 23, 2006 11:16:54 AM
Thanks for the link. Whoeverur
Funny that the blowup in MBS mkt coincided with massive $117 bil net capital inflow to the US and a takeoff in stocks.
"Hankie, you're doing a heck of a job!"
Was that a record inflow?
Posted by: tjofpa | Oct 23, 2006 11:27:57 AM
I think the most interesting thing in the WSJ story is the data on interest rate levels vs. inflation, inflation expectations, etc. I mean, inflation basically tripled off its lows, and both core and headline CPI hit the highest levels in years and years. The Fed responded with 17 short-term rate hikes worth 425 basis points spread over a two year period.
And long-term rates? They went basically NOWHERE. Why the bleep are 10-year yields below 5%? Or 6% for that matter? That's the question that really begs to be answered. Whether it's the massive buying/recycling of funds from overseas reserve managers full up on dollars, or something else, only history will judge. But we have truly never seen an interest rate cycle like this one. It's like those guys in the the pits of Chicago slept through the whole cycle. Crazy
http://interestrateroundup.blogspot.com/
Posted by: Mike_in_Fl | Oct 23, 2006 11:33:04 AM
calmo -- I was really just being sarcastic about the weak dollar.
Posted by: spencer | Oct 23, 2006 11:40:04 AM
Hey hey, hey hey, buy stocks every day.
Posted by: Chris | Oct 23, 2006 12:39:34 PM
A nice comparison, which to me also suggests the Fed may not switch to easing so readily. However, the market is far more sensible with respect to pricing in the future course of Fed action than it was a few weeks ago. Furthermore, just because the Fed may not move to an easing bias readily, I find it difficult to jump to the conclusion that 'The exercise gives the entire soft landing thesis a splash of cold water . . .' Just thoughts.
Posted by: Abobtrader | Oct 23, 2006 1:07:59 PM
If you lower the standards for all types of loans whether that be mortgage, commercial, or corporate and there's someone on the other end prepared to buy that debt created, then you can have a soft landing theoretically by plugging in these "new values" into the "new paradigm". Isn't that what's being done? But isn't this really a question of morals, a proper code of conduct, and family values?
Posted by: teddy | Oct 23, 2006 1:49:34 PM
"BR Ed, I recall after the 87 crash and the fed cut, we had a nice housing spurt for 2 years -- in NYC, there had been a massive condo/coop conversion from rentals in the 80s, and that post crash boomlet was probably the last spurt. "
I don't disagree, though most people I know who bought in the 80's, lost value well into the 90's.
The main point is that 1995 was a year in which real estate was on the upswing, coming out of a down cycle. Now we are at just the beginning of what looks like a colossal down cycle. So comparing 95's soft landing to today is silly.
Posted by: edhopper | Oct 23, 2006 3:43:39 PM
Link to the Bloomber ABX article mentioned above:
Housing Slump in U.S. Poised to Worsen, Derivatives Trades Show
-Don't get me wrong, i'm bearish on the US resi mkt, but to put things in perspective, the ABX tranches that are most active are the BBB & BBB- of the ABX. BBB & BBB- tranches in the cash mkt are extremely thin, about $10-30 per tranche per issuer; compare that to the std. deal size which is ~ $1 bln. Strategists for months have been advocating a particular trade, buy BBB/- cash as well as protection in the ABX BBB mkt (which pushes the spread out), esentially a married put position with great carry. I think thats partly one of the reasons the ABX has gapped out, its a crowded trade. CDO's have been taking the other side of this trade (they go long synthetically) which up until a couple months ago has kept spreads in check.
Posted by: phil | Oct 23, 2006 8:38:40 PM
you could have included the mandatory (and massive) Y2K computer upgrade that took place throughout the mid-late '90's.
Posted by: dave | Oct 24, 2006 12:01:22 AM
