May 24, 2006

Housing

This morning’s report of April’s 4.9% increase in new home sales is nothing more than an aberration in a growing bear market for house prices. Buried deep in the report was the fact that sales for January, February and March 2006 were revised downward with March leading the way with a revision of -71,000. Sales are NOT the big story as prices of new single family homes have increased only 0.9% in the last twelve months and a record 565,000 homes are sitting on the market waiting for buyers. This supply represents 5.8 months of sales and unless we see a recovery in June (usually the strongest month for home prices each year) we are sure to see more record increases in supply and the beginning of what should be a slow, painful period for home owners that are praying for higher prices so that the ATM machine (house) never runs out of money. I often read that the housing market will stay strong until the economy and job market softens. With over 40% of new jobs in the US coming from real estate in the last 3 years it should only be a few more months before a massive exodus occurs in many of the RE related industries. This morning’s Seattle Times headline “WaMu slashing 850 local jobs” isn’t surprising as this is a continuation of a trend that began earlier this year.
From Sacramento we see that more homeowners are behind on their mortgage payments. One mortgage broker commented correctly that “many people can’t afford both rising mortgage payments and their cars, credit cards and other amenities.” The Fed tightens, oil prices rise and the homeowners’ last option continues to be the refi…soon that door will shut tight. Stable house prices will place many homeowners in a position where massive spending cuts will be the only route to prevent eventual foreclosure…..it’s not pretty and I really don’t see any other way out for the many thousands who purchased houses/condos with no money down……

When prices rise, supply increases and then…

According the World Gold Council jewelry demand fell 22% in the first quarter of 2006 as the price of gold rose to a 26 year high. Almost 2/3 of global jewelry demand comes from Asia and the Middle East but even regular buyers slow down their purchases when prices rise. So why did the price of gold continue to rise until about a week ago? Billions are being invested this year in commodity funds and ETF’s (exchange traded funds) as the individual investor chases the mirage of big profits from the rise of metals and other “hot” commodities. The problem is that with growing markets everyone seems to want to enter and exit at the same time and that is why we are witnessing such large movements (gold down $20 today) over the past few days. Last week I wrote about the fact that traded commodity prices have risen almost 35% more this year than those that don’t have publicly traded markets. Corn futures are publicly traded and have risen almost 20 cents a bushel since March but mostly due to heavy demand from these “new” hedge funds. The cash price of corn that farmers and others involved in the business have NOT risen at all and that may be the most important point to emphasize in this atmosphere of inflationary expectations. It appears that the demand for most commodities that have risen this year is not coming from normal places (producers, growers, end users) etc. but from speculators who would never want to actually take delivery of the product or commodity that they have bought….the big question will soon be asked: To whom are they planning on selling when they want or have to get out? With the Fed having raised short term interest rates for the past 23 months the cost of carry has become expensive for these hedge funds and if these markets don’t continue to rise it will become very painful to just hold on to existing positions.

June 30th: Will the Fed raise rates again?

The next FOMC meeting will take place on June 29th & 30th and much can happen in the economy before the meeting and Chairman Bernanke is hoping that a definitive trend begins that will make his decision easier than if it need to be made today. The new Fed Chairman’s credibility has been criticized over the past few weeks as he clearly has seemed confused about future Fed policy and somehow disclosed publicly (to CNBC’s Maria Bartiromo) that Fed policy was still to be determined…Yesterday he actually scored a few “cred” points when testifying before the Senate Banking Committee that the conversation with CNBC “was a lapse in judgement on my part” and that in the future “my communications with the public and with the markets will be entirely through regular and formal channels.” (FOMC statements). This is a start and we must remember that Mr. Greenspan made similar communication errors in his first year (1987). The Fed has appox. 30 days to determine whether it feels it needs to tighten again on June 30th by raising the Fed Funds rate by 25 basis points. We will have many economic releases during this period including tomorrow’s GDP report, Friday’s PCE (inflation) report and of course the employment report on Friday June 2nd. Even though the Fed has said it is “data dependent” it must be careful that it doesn’t react to current or past economic growth numbers because monetary policy clearly has a 12-18 month delay and what appears to be inflationary fires today might turn out to be economic weakness and/or low inflation in 2007 when the effects of an increase in short term rates actually filters thru the US economy. It is a tough job and that is why there have only been five Fed Chairman in the past 30+ years. There are two important points that Mr. Bernanke and the FOMC will consider before making any decision in policy. 1) Over the past 30+ years inflation has peaked approximately 15 months after the peak in GDP growth and that would put the peak of inflation in early 2007 which is less than the 12-18 month lag from Fed monetary policy. 2) IF and it is a big IF the Fed raises the Funds rate to 5.25% on June 30th and IF the 10 year T-Note stays around 5.00% we will have a 35% of having a recession later this year. This probability comes from the “famous” 1996 study done by the NY Fed at the request of former Fed Chairman Alan Greenspan. The interest rate market should give us the answer over the next 4 weeks so I would urge everyone to pay close attention to the rate on the 10 year Treasury. A declining rate will give the Fed cover for no rate increase but a rising rate will leave the Fed no choice but to raise the Funds rate to 5.25%. Stay tuned…..it’s going to be a volatile and exciting June in interest rate land.

May 15, 2006

What goes up, must come down…

Amazing what a weekend can do to clear the minds of commodity investors. Beginning with trading last night in Australia and then onto the Far East, Europe and the US we saw continuous selling of metals (gold down over $20, oil down $2) and other commodities that have been rising in parabolic fashion for months. It is clear that demand for gold, silver, copper, zinc, etc. has been driven by speculators and hedge funds and these are non-users so when it is time to get out we see a stampede for the exit door. I found an interesting article in Saturdays London Telegraph which talked about how the price of copper has doubled this year but industrial demand remains flat. It appears that demand for copper tubes is collapsing as producers switch to plastic. I have written many times that price rises are followed by an increase in supply and a drop in demand as buyers find alternatives. The most telling part of the copper story is the fact that copper for delivery in 5 years is selling for only 42% of the price today. ($8,875 today vs $3778 in 2011) This is must reading: http://www.telegraph.co.uk/core/Content/displayPrintable.jhtml?xml=/money/2006/05/13/cncopp13.xml&site=1

Housing prices in Florida headed South

Sometimes the most objective writing comes from afar and in Saturday’s edition of the Canadian Post comes a story about the South Florida housing market that appears on the verge of a collapse. With US single-family house and condo inventory at a record 3.5 million (30% higher than a year ago) investors are walking away from deposits as high as $80,000 to free themselves from the “for sale” signs that are sprouting up in Florida. The most interesting quote in the article is a prediction of 30% less mortgage brokers in 18 months. Although many are welcoming this pull back in home prices it is hard to believe that investors will come back for more since they are having a hard time selling what they currently have on the market. Another good article: http://www.canada.com/components/print.aspx?id=41c3b5c5-a34d-424e-93ae-50d6b1666921&k=70496

Loan Officer Survey shows same old thing…

The Federal Reserve published its quarterly loan officer survey and I am sure they are not pleased with the results. It showed that credit (underwriting) standards were unchanged in April for residential mortgage and consumer loans. The Comptroller of the Currency is in the final stages of issuing new regulations for house lenders that will make it more difficult to borrow on high leverage as has been the case in the past few years with so many new home purchases. The survey also showed that most lenders lowered margins (profits) and extended maturities on commercial and industrial loans. Nothing has changed as banks are all chasing too little product with too much money and this is not a good reason for the Fed to even think about easing at this point in the credit cycle. An accident is on the way unless something changes soon…http://www.federalreserve.gov/boarddocs/snloansurvey/200605/

May 12, 2006

The test of every Fed Chairman

As long term interest rates continue their daily climb following metals prices into orbit (copper, silver, zinc, aluminum, etc.) I thought it would be useful to go back in history because something seems familiar. As most of you know I have been studying interest rate patterns for almost forty years and in that time we have had five different Fed Chairmen and in each case the first few months have not be pleasant for the incoming Fed head. I have put together a table showing each of the five periods measured from the first day in office until the first peak in the 10 year Treasury rate. I will let you come to your own conclusions but it is clear that long term interests have risen quite a bit after the inauguration of each Fed Chairman.

The good news is that after each one of these periods of rising interest rates we saw a quick and sharp decline in rates. Although it is impossible to know how much further rates will rise this year I continue to believe that the two high speed trains (commodity prices and the Fed Funds rate) are headed for a crash which will be the catalyst for the rate decline I am expecting later this year.

Next week’s calendar

With Mr. Bernanke and the Fed declaring that future monetary policy will be “data dependent” we have quite a few important events next week. Tuesday (May 16) will see the Fed Chairman speaking in Atlanta at 3:30pm. Wednesday (May 17) we have the Consumer Price Index release at 5:30am. Thursday (May 18) could be the highlight of the week as former Fed Chairman Alan Greenspan speaks in New York at 2:30pm. It will be interesting to hear Mr. Greenspan’s views on current Fed policy and the recent rise in long term interest rates.

Consumer spending is slowing

This week it was reported that retail sales in April increased 0.5% but excluding autos and gasoline it was only a 0.2% increase and with oil prices higher in May the consumer is clearly becoming “tapped out.” Of note is that April was a great weather month across the country but sales of building supplies plunged 1.6%. We are just days away from June (the strongest month for home prices) and any price weakness will spell trouble for home sellers in the 2nd half of this year.

Summing up

Nothing has changed, the new Fed head continues to show a lack of leadership….what’s needed is a BOLD move not seen in many years…a 50 basis point increase in the Fed Funds rate approved in a FOMC tele-conference that will shock the world and give the Fed instant credibility in its fight against future inflation…. This would drive US long term interest rates sharply lower and return confidence to the dollar.

May 10, 2006

Yet?

Expected: This morning’s Fed announcement of a 16th consecutive increase in the Fed Funds rate to 5.00%. NOT expected: The addition of the word “yet” into the statement http://www.federalreserve.gov/BoardDocs/press/monetary/2006/20060510/default.htm released by the FOMC that has world wide Fed watchers scratching their heads. The key sentences from today’s statements were the following: “As yet, the run-up in the prices of energy and other commodities (copper up 50% in the last 2 months) appears to have had only a modest effect on core inflation.” Further policy firming may yet be needed to address inflation risks but the extent and timing of any such firming will depend on incoming information.”

Confused

The Fed is clearly confused about the direction of short term interest rates. On the one hand they see house prices softening in many parts of the country which sends a message that the economy may be entering a weak period and low inflation. On the other hand they see rising oil, copper, aluminum, gold, silver, sugar, etc. prices that send a message that the inflation monster may be about to enter the main economic arena. The problem is that the Fed is telling everyone every little thought that pops into the head of each FOMC member and this is only confusing the world’s investors that are seeking direction and have come to expect it after 17 years of Alan Greenspan as Fed head. Mr. Bernanke is finding that the job of Fed Chairman is anything but easy and even harder when you follow a legend.

Direction of long rates

The most important indicator for Mr. Bernanke should be the direction of long term interest rates which have risen non-stop since early January 2006. The Fed needs to see long rates drop for a few months before it can even consider the end of this tightening cycle. I have always found that the Fed’s forecasting models were never as accurate as the long end of the interest rate market which always seems to sniff out an imminent decline in inflation and/or economic growth. Mr. Bernanke’s “cred” needs some boosting and he will be very careful to make sure he has everything lined up just perfectly before he changes the current FOMC direction. He has been somewhat boxed in by the recent increase in gold and other metals prices and is going to have to wait until they show signs of topping before any policy changes.

The next 50 days

June 29th is the next FOMC meeting and I believe that Mr. Bernanke has no idea what he will recommend to his FOMC teammates on that day. They will be closely watching commodity prices, housing sales and prices, commercial and industrial loan demand, long term interest rates and then their own forecasting models. If, and its a big if, long term rates decline between now and the next meeting date the Fed would have more reason to halt the 2 year increase in the Funds rate. If long term rates continue to increase it will be almost a sure bet that the Fed will increase the Funds rate to 5.25%.

Conclusion

It is never easy waiting for what you need as patience wears thin when the wait becomes costly. Unfortunately Mr. Greenspan is no longer Fed Chairman so the interest market is testing Mr. Bernanke almost daily but it won’t take more than a few more months before his “Fed cred” increases enough for the long rates to begin believing in his inflation fighting abilities and long rates will see their lows later this year. Hang in there, the long wait will be worth it!

May 8, 2006

It’s Fed time again

Wednesday May 10th is the next FOMC meeting and luckily for Mr. Bernanke he will have the chance to carefully craft the statement that will be released at 11:17am. The Fed will announce another 25 basis point increase in the Fed Funds rate to 5.00% and probably change the language of the accompanying statement to add “data dependent.” This will be the first positive step for the new Fed Chairman in his drive to increase his “credibility” quotient with the world’s financial markets. The Fed needs to be clear and have a consistent message that is easily understood before long term interest rates can begin their long awaited decline to new lows that I expect in the fall of this year.

Housing prices

A recently issued report by Pimco http://www.pimco.com/LeftNav/PIMCO+Spotlight/2006/Housing+Project+Simon+Interview.htm talks about house prices continuing a slow climb due to strong job condition using the early 1990’s and 1980’s as examples of house price declines that were caused by massive job losses. This is the same story that all home builders are using as evidence that it is not too late to build or buy a new home. Job losses and the economy are important but we have never had a time in history where so much of the economic growth was created by the building and real estate industry. Much of the recent price appreciation has been a function of speculators and home buyers who found lending and interest rate conditions too good to pass up. The lending conditions will change for the worse before the end of the year as the comptroller of the currency is in the late stages of issuing new regulations. The interest rate conditions will deteriorate further until later in the year. What worries me the most is the insatiable demand from people who are just waiting and hoping for a pull back in prices so that can jump in and buy anything with four walls. My warning to those is to be careful of what you wish for because you might find yourself in a box with no exit door.

May 3, 2006

Interest rate movements are all about Fed credibility

At the November 15, 2005 Senate hearing to confirm the new Fed Chairman Ben Bernanke made the following statement:
” Monetary policy is most effective when it as coherent, consistent, and predictable as possible, while at all times leaving full scope for flexibility and the use of judgment as conditions may require.” Unfortunately Mr. Bernanke is following a legend (Alan Greenspan) and just like poor Gene Bartow who followed the legendary coach John Wooden at UCLA (1975) there is almost no way he can create his own legend (unless it is littered with mistakes) in a few months and the interest rate markets are going to give him a lesson he won’t forget for a very long time. Last week in testimony to the Congressional Joint Economic Committee Mr. Bernanke stated that the FOMC might find a time that it would not increase the Funds rate as it has done at every meeting since June 30,2004. Then on Saturday evening he made a “rookie” mistake that I’m sure only made Mr. Greenspan wince in agony as Mr. Bernanke spoke to CNBC reporter Maria Bartiromo at the Washington correspondents dinner for President Bush. In clear “on the record” remarks he told her that Wall St.’s reaction to his testimony was “wrong” and that the bond market believes he is a “dove” on inflation. Hopefully Big Ben learned a lesson this week as the interest rate market is now more confused than at any time in Mr. Greenspan’s term. I have written for many years that the biggest obstacle to any market is “confusion” and that the greatest ally is “certainty” even it is bad news. The new Fed Chairman had better make his future pronouncements clear and then stick to them or he will find himself and the Fed “behind the curve” and the only way to catch up will be to raise the Funds rate higher than anyone expects in an effort to show the markets that he really is a “tough” inflation fighter.

Some big news about the housing market

At 4:30am this morning (I am always up anxiously awaiting for the day’s economic news) the Mortgage Bankers Association announced that refinancing applications rose 5.1% last week which is extraordinary considering that interest rates have been rising almost daily for the past 3 months. Normally refinance applications fall when rates are rising and increase when rates are falling. Digging a little bit into my data base I found that according to Freddie Mac 88% of people who refinanced their homes in the first quarter of 2006 took out loans for at least 5% more than their original balances. The 88% level is the highest since the third quarter of 1990 which coincidentally was the peak of the last major real estate cycle. Freddie also noted that $59.6 billion was cashed out of homeowners equity thru 3/06 and that is down from $70.9 billion in the fourth quarter of 2005. The important point is that homeowners refinanced in a rising interest rate environment and took cash out because many of these borrowers probably couldn’t make their monthly mortgage payments without additional cash and since the average American has no savings the only place to go for more $$ is the house that has been rising in value. When house prices stop rising (soon) this game of musical money chairs is going to end in disaster for the thousands that have played this game and now have no equity left in their houses. I should note that Freddie Mac’s data only covers conventional loans. When this train hits the station with no brakes remaining long term interest rates will plunge but as I have said all year the best of the interest rate market won’t hit until the fall/winter of 2006.

Default notices on houses climbing

According to DataQuick, the counties of Sacramento, Yuba and Placer (all in California) showed 50-100% growth in default notices in the first quarter of 2006. Although only about 5% of default notices usually result in actual foreclosures it is a sign that the times are changing…If house prices were still rising wouldn’t it be easier for the average homeowner to just refi again and again and again to take more cash out to make the monthly payments? Did you know that almost one million homeowners were at least 60 days delinquent on their house payments as of the end of 2005? (data from MBA) The end is coming for those that have taken advantage of the rising tide of house prices but one of my favorite expressions is about to take hold: “don’t ever confuse a bull market with brains”. The smartest people I know have taken their chips off the table so that they will have plenty of money to play another day.

The next bull market?

Alternative energy sources should be the next BIG bull market with ethanol leading the parade. It appears that a growing industry is home made ethanol kits that enable a person to brew your own fuel for just 75 cents a gallon. The story: http://www.wgal.com/print/9040469/detail.html

Conclusion

I have received many e-mails over the past few days asking if I still believe that long term interest rates will be lower in the fall of 2006. The answer remains yes but we may have more pain ahead as the Fed is on a collision course with the commodities markets (fear of inflation) and the long term interest rate market (fear of no Fed credibility) so the Fed may have to show it is serious about the future by raising short term rates higher than anyone expected and then suffering the consequences of over shooting (a favorite Fed pastime) which will have long rates headed for all time lows later this year.