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The Fed's New Conundrum: Slowing Housing

Yesterday' 1/4 point rate hike was no surprise . . . but the thought processes behind it may be. Consider the conundrum left to Ben Bernanke by his predecessor, Alan Greenspan.

Post market crash, recession, 9/11, and Iraq War, this was a flatlined economy. Anytime a major market takes a 78% whackage, huge swaths of capital gets destroyed. The Fed's response to this was to slash interest rates to half century lows.

The initial results of this were somewhat predictable: the Housing sector accelerated and the global economy reflated. Back in December 2002 I mentioned that investors might want to watch gold due to the inflationary potential of these ultra-low rates. (Not quite the table pounding of last year, but quite timely).

At the same time, China began building out its infrastructure in anticipation of its Olympic hosting duties. Concurrent to this was the enromosu boom in direct China investment by Western companies, all seeking to dramatically lower their costs.

Technology companies may not be the benficiaries of this -- at least not their stock prices. The subsequent economic expansion was atypical and lumpy, unevenly distributed. Leadership came from Housing, Materials, Energy, Industrials and Transports -- not your typical bull market leaders. Noticably missing were Technology and Financials. How's this duality: Job creation was amongst the worst on record, yet profits are at the top of historical ranges. Housing drove employment, consumer spending, and sentiment.

Then there was inflation. Despite the tortured gyrations that the BLS and Fed goes through, only the most myopic or clueless economists continue to deny the robust price increases across industrial metals, health care, housing, energy, precious metals, insurance, food, education, transportation. Indeed, the only place inflation has been well contained has been wages. 

Since August 2005, we described what we saw as the cooling beginning in Real Estate. Yet despite this slowing, and its eventual impact on consumer spending, the same inflation pressures remain, mostly due to Globalisation and demand from Asia. 

Hence, the conundrum. The Fed cannot risk allowing very apparent commodity inflation pressures to continue to rise unabated; at the same time, the end of the housing rally is clearly in site.

This is the conundrum that led IMO, to the "Pause" line of thinking.

~~~

So where does that leave us? Pimco's Paul McCulley notes that housing related demand for credit is one of the key elements in money growth. Getting the balance right of credit and money supply versus demand, the Monetarists warn us, is a key element in keeping inflation under control. 

Meanwhile, there is little evidence that the nation's "obsession with real estate is abating," notes the WSJ.

The takeaway of all this comes from Harpers magazine, who may have accidentally come up with the most astute visual. Their most recent issue has an article on "The New Road to Serfdom: An illustrated guide to the coming real estate collapse."

That's supposed to be John Q. Public shouldering the exotic interest-only no-money-down mortgage load in the graphic.

Instead, I think that's a drawing of how Ben Bernanke must feel:  He's facing monetary pressures at home, a slowing U.S. economy as Real Estate cools, and hot global inflationary forces beyond his control short of forcing a global recession.

A soft landing for a man shouldering that load looks increasingly unlikely.

Source: Harpers 

Thursday, May 11, 2006 | 08:00 AM | Permalink | Comments (50) | TrackBack (0)
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Comments

it's interesting that the chart of the ffs rate looks just like the chart of the Dow over the same time period. it also corresponds to margin debt levels on the NYSE. traders borrowed the most money in 3/00 when the ffs rate and stocks were at the high and borrowed the least amount (at least over the last cycle) in 9/02 a month before the low in stocks and just off the low in ffs rate. today the level is, you guessed it, back to where it was near the top in 12/99. traders borrow more more money as rates go up and less when they go down... i'm no economist but that flys in the face of logic.. what will it portend for stock prices?

Posted by: vf | May 11, 2006 8:48:09 AM