The plane, the plane…….the yield curve, the yield curve…..

From 1-28-78 until 5-19-84 ABC aired a very popular show called Fantasy Island. Tattoo (Mr. Roarke’s sidekick) would always announce the arrival of guests to the island with the words “the plane, the plane.” Today Tattoo would be welcoming the many economists/experts who are living in a “fantasy world” by advocating that the Fed raise the Funds rate at the next meeting (9/20) and continue until reaching the 6.00% level. Yes, inflation is higher than it should be but chasing a late cycle is not good monetary policy and would put the Fed back where it was earlier this year when it was spending too much time looking at the rear view mirror of the economy. It is clear that the US consumer has kept the economy growing at a 3.5%+ rate for the past couple of years but with the housing market beginning a long bear market the ability of consumers to tap housing equity is ending quickly.

Loan demand weakening?

The price of money (interest rates) is determined by the demand (those that want to borrow) and the supply (Federal Reserve money supply and velocity). The Fed closely watches loan stats that are released each Friday at 1:15pm and recently we have seen a slowdown in the real estate category. After growing at double digits for the past few years we have seen the last four weeks show almost no increase and that could be the start of something important. The commercial and industrial loan category continues to grow and these loans sometimes take months to close so the numbers don’t always give us the lead time that is preferred but the Fed is staying in close contact with bank lending departments so their information is far ahead of the loan stats. IF, and it is a big IF, loan demand begins to slow over the next few months the Fed will be forced to lower the Funds rate much faster than the normal six month period that is typical of Fed transitions from tightening to easing of monetary policy.

Yield Curve

One of the most important keys to my interest rate forecast comes from the yield curve, the relationship of short term and long term interest rates. With the US 10 year Treasury currently at 4.81% and the Fed Funds rate at 5.25%, an inverted yield curve is making the Fed very comfortable with current monetary policy. Although the long end of the market needs a rest before continuing on its march to the low 4.00% region, the Fed will be able to follow the long end down and begin to lower short rates when its sees more signs from the housing sector that show a drop in consumer spending.

The deteriorating housing market

This morning Toll Brothers (luxury home builder) reported lower earnings and millions of write-offs due to sales of lots that were going to be used to build more homes. As always the most important part of the earnings release was buried in the press release: http://www.tollbrothers.com/homesearch/servlet/HomeSearch?app=IRshell&file=IR_20060822.html
Robert Toll, CEO, stated: ” The continuing malaise in the housing market, we believe, is the result of an oversupply of inventory and a decline in CONFIDENCE….anxious buyers are canceling contracts for homes already being built…..keeping buyers on the sidelines as they continue to worry about the direction of home prices.” This is must reading from the head of one of America’s top home builders. The key word is confidence and this is something that took years to build up and will not come back quickly……home buyers are motivated by the need for shelter but also by greed (rising prices) and fear (higher prices later) and this is something that will not return for many years…I warn everyone as strongly as I can that this coming correction is not temporary but a process that will take years to develop and by the end most will have given up hope of any return to the good old days!

Having trouble selling your house? Maybe a statue will help….

The hottest selling item across the country is St. Joseph statue which somehow brings good luck? to those who bury the statue upside down and then St.Joseph will send buyers to your house. As Jim Healy (radio) used to say: “I don’t make ‘em up!!” Sales have doubled at http://www.stjosephstatue.com/ and for more information about desperate measures by sellers: http://www.boston.com/news/local/massachusetts/articles/2006/08/20/when_sales_fall_they_call_st_joe/?page=full

Upside down and no where to hide

A few months ago we were told that the Australian housing market was rebounding to new highs…Last week a three bedroom house in St. Clair sold for $260,000 down from the purchase price of $450,000 in 2003 and unfortunately much lower than the current mortgage of $405,000. We will soon be reading these same stories in the United States.
http://www.smh.com.au/news/national/housing-crash-puts-sellers-in-debt-crisis/2006/08/20/1156012414995.html

Funny numbers in housing land

The number of houses for sale and how long they have been on the market may not be as accurate as we believe as RE agents in Philadelphia have been taking property off the market and then re-listing to make it appear that it is a “fresh” offering: http://www.philly.com/mld/inquirer/15314072.htm The best quote from the article is from National Association economist Lawrence Yun: “The current psychology is pushing buyers to the sidelines until they see what happens”. Uncertainty is what the markets can’t handle and always lead to price declines…BTW: According to this morning’s NY Post, the supply of Manhattan homes is at the highest level in 10 years.

Lower property sales = lower state tax revenue

Many states have reduced budget deficits or even had surplus tax revenues due to the sales tax effect from rising home sales. But with almost every state showing a dramatic slowing of purchases state tax revenues are beginning to decline and that has many worried that state budgets won’t be balanced this year. (Unlike the federal government individual states can’t print money to make up the deficit). http://www.wcsh6.com/news/article.aspx?storyid=40449

Summary

The US housing market is in a free fall that has no immediate stopping point. The speculators will need to liquidate and the highly leveraged homeowner (43% of first time home buyers in 2005 put NO $$ down) will soon need to find new ways to make the monthly mortgage payment. According to WaMu’s annual report almost 50% of options arms’s were in negative amortization (unpaid interest added to principal) at the end of 2005. The vultures are out there waiting to buy the first dip and will learn quickly that the bear market “mauls” all that stand in its way.

The good news is that long term interest rates have begun a move to much lower levels which will help some borrowers maintain their residences for now….in the end not even lower interest rates will save the highly leveraged home owners who will soon learn the age old lesson: don’t spend what you don’t have

As always, I welcome any questions or comments to these e-mails and I will be teaching another interest rate class in Los Angeles in October with a specific date to be announced soon.

The Three F’s…

The Facts: Wednesday’s core (no energy or food) CPI showed a 2.7% rise in the past 12 months. The housing starts (-2.5%) and permits (-6.5%) showed that the bear market in residential real estate has picked up momentum. This morning the 10 year US Treasury rate dropped to 4.85% (the exact level I forecast in my July 19th e-mail).

The Fears: The Wall Street experts continue to sing the “stagflation” tune where the economy stays strong but inflation rises and the Fed is forced to raise short term interest rates to 6% or higher. If only these economists were forced to “mark to the market” their predictions like the investors who have put their hard earned money into investments that need higher interest rates to be profitable. Economic forecasting is the only business in America where if you are correct no more than 3 times out of 10 you are considered a genius.

The Fed: Mr. Bernanke is looking prescient as the FOMC’s August 8th statement emphasized that near term inflation was something the Fed could NOT control but the past 17 interest rate increases would surely create resistance for any inflation increases in late 2006 and 2007. It is clear that the Fed is much more worried about the housing slowdown creating a loss of jobs which will slow US economic growth and any lingering inflation.

Outside the US

Iceland’s central bank raised its overnight lending rate on Wednesday to 13.5% from 13.0%. With a current inflation rate of 8.6% it would appear that the Iceland monetary authorities are way ahead of the financial curve until you realize that they have a target annual inflation rate of 2.5%! (Ouch!) Raising short term interest rates will eventually slow inflation but at a huge cost to the Iceland economy. 2007 will bring many stories about this economy on the verge of collapse.

US home prices have risen in the past couple of years because of investor demand and buyers from overseas seeking a good return on dollar based assets. Wednesday’s UK Telegraph had an article on its front page about the collapsing US home market. This is sure to give UK investors a pause in their rush to the states to buy property. http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2006/08/16/cchouse16.xml

Chinese money supply growth is over 18% a year but their inflation rate is only increasing by 1.5% a year. Why? It’s called low velocity and excess capacity utilization. Increasing money supply is not inflationary if loan demand is increasing at a smaller rate than the economy (see Japan 1995-2005).

Finally I find it interesting that in the face of an end to Fed tightening that the dollar has been able to stabilize against most world currencies and that commodity prices have not resumed their summer rally. Most of the inflation worries have come from the increase in the prices of many metals (copper, silver, gold, etc.) and now with an end to Fed interest rate increases they don’t seem to want to rally…..if this continues it will enable the Fed to begin its easing earlier than normal (6 months average pause).

The US consumer spending versus Fed tightening

Growth (13 week rate of change) in the US adjusted monetary base has slipped below 0.0% and this is something that has occurred only three times in the past 40 years. The Fed is clearly NOT creating money for the US consumer to spend and since the US savings rate is negative and gasoline prices above $3 a gallon the consumer is clearly stretched to the limit. Last Friday’s (8/11) retail sales increase was hailed by the press as showing that consumer demand was still going strong BUT digging into the details finds that over half of the increase is from gasoline sales. The percentage of retail sales represented by gas sales is now at a high of 4.88% versus the normal 3.75% of the past many years. It is clear that drivers are buying gasoline but cutting back on other less necessary purchases.

The BIG story

The big, bad and very slow bear market has begun for the US housing market. I have written that crashes only occur in bull markets and that bear markets last years and see long slow declines and the housing market will be no exception. I am amazed at the amount of press given to sales numbers for houses in the past month. Can you imagine the nightly news telling us that the stock market had volume of X# of shares today but not disclosing the direction of prices? Sales volume will only be significant when sellers finally give up all hope of obtaining their desired prices and let go at prices they never dreamed of…..Most markets allow short selling which is the biggest reason that prices don’t fall dramatically….short selling is a bet on lower prices and is done in the stock market by borrowing someone else’s stock and then selling with a promise to give back the stock when you purchase at a hopefully lower price. Unfortunately residential real estate has not created a way to “sell short” as it would be next to impossible to borrow someone’s house and then sell (where would the owners move to?) at a high price and then magically buy back the same house?? It will never happen…as a result there are no speculators or investors who can easily buy homes on the way down and thus profit from lower prices. The second problem is that many recent home buyers purchased houses sooner than they should have (income not high enough for mortgage payments) but because of a sense of urgency and a fear of higher prices next month, they jumped in with a % down home loan (43% of first time buyers put no $ down in 2005). This worked for a couple of years but with home prices leveling off and soon to decline these homeowners will be unable to borrow more $ to maintain their high mortgage payments and nice life style.

In the 1st quarter of 2006 more than 50% of cash out refinancings were done at a HIGHER interest rate….this reminds me of the loan shark that loans $ to his clients for the sole purpose of staying current with their regular payments.

Last week USA Today ran an article with the fact that the national median mortgage is now $1687 a month versus the median rent payment of only $868 a month. Yes the houses are probably more square feet than the apartments but soon rental rates will be declining due to an oversupply of houses and condos that can’t be sold and must be rented for the owners to collect at least some income to offset their mortgage payments. http://www.usatoday.com/money/perfi/housing/2006-08-09-rent-1a-usat_x.htm

Earlier this week the NAHB (National Association of Home Builders) announced that their building index fell to a 15 year low. The significance of this statistic is that over the past 25 years their index has led retail sales both up and down by about 1.5 years. By mid-late 2007 we will have a dramatic cutback in consumer spending accompanied by much lower home prices (especially in Nevada, Florida, California).

Best quote of the past week comes from Robert Toll, chairman of Toll Brothers, one of the biggest home builders in the US: “It is the first downturn in the 40 years since we entered the business that was not precipitated by higher interest rates, a weak economy, job losses or other macro economic factors.” “Instead, it seems to be the result of an oversupply of inventory and a decline in confidence.” http://www.tollbrothers.com/homesearch/servlet/HomeSearch?app=IRshell&file=IR_20060809.html

The 2nd best quote comes from Eli Broad, founder of KB Home in Los Angeles: “I don’t know how soft the landing’s going to be, I think we’re in for a period of a year or two years where housing prices are going to go DOWN or stay stable, but certainly NOT go up.” http://www.latimes.com/business/la-fi-homes16aug16,1,1446316.story?coll=la-miniav-business

These are two of the brightest minds in business today and normally are very positive about future economic conditions. If anything they are probably understating the blood bath that is soon to come to a neighborhood near you and I….it’s not going to be pretty and the worst part is that 99% of American is in denial….they believe it is a right as an American citizen to buy a house and that prices always rise…..

Best runner-up quote came Wednesday from Dallas Fed President Richard Fisher: “If anybody tells you with absolute conviction that the Fed is done raising interest rates or with equal conviction that they have only paused and will raise rates more starting in September or October, remind yourself that at best-and I’m being generous here-they are only guessing.” http://dallasfed.org/news/speeches/fisher/2006/fs060816.cfm I agree with him completely…The Fed will be closely watching incoming housing and other economic data and will react accordingly but looking for any reason to lower short rates as long as long rates are declining…….

Sacramento is immune to the housing price collapse?

In the face of rising supply and lower prices Sacramento investors are whistling past the grave….five Sacramento County apartment owners are seeking approval for 700 new condo conversions. I wonder how long it will take before they come to their senses and cancel this project? Bear markets are vicious but we always find a few that believe that catching a falling knife is easy…only to realize that more often than not they catch the blade not the handle…. http://www.latimes.com/business/la-fi-homes16aug16,1,1446316.story?coll=la-miniav-business

Good news: Long term interest rates continue to decline

After a wait of 301 days we have finally had a 40 basis decline in the US 10 year Treasury Note. It was a long wait but this should be the beginning of the drop I have been forecasting since the beginning of the year. It will not occur quickly and the Fed will not begin to lower the Fed Funds rate any time soon but as long as we have the majority of experts telling us why the Fed should/will raise short rates we will stay in a trading range that will move lower over the next few months. On a very short term basis for those real estate professionals looking to lock loans, the market is tired from its 40 basis point run and needs at least a few days/weeks to catch its breath.

Longer term, the bad news is that lower long term rates will NOT help the housing market but will tease everyone into believing the worst is over and giving the impression that its time to jump back on the housing train. That train has run out of fuel (negative savings, low personal income) and it will be many years before it can make another run…for the next 10 years the BIG money will be made from investments in alternative energy and defense. The best investors always know when to hold them and when to fold them and the best of the best have been cashing in their chips for the past year while others take their place at the table and learn the lesson of their life that they were too late……

As always, I welcome any questions or comments to these e-mails and I will be teaching another interest rate class in Los Angeles in October with a specific date to be announced soon.

A fed pause? More likely the end……..

Tuesday’s FOMC announcement sounded much like Roberto Duran’s ending to his famous 1980 rematch fight against Sugar Ray Leonard with the words “No Mas.” After 24 months and 17 consecutive rate hikes Fed Chairman Bernanke announced he had enough and ended of one the longest chapters in Fed history. The press release made mention of a cooling in the housing market and lagged effects of past interest rate increases and energy prices. http://www.federalreserve.gov/boarddocs/press/monetary/2006/20060808/default.htm . Most importantly the Fed stated that current inflationary pressures seem likely to moderate over time which is direct contrast to the many “experts” that had been predicting another rate increase due to current inflation rates of 2.5%. There was no mention of rising labor costs even though Tuesday’s release of Unit Labor Costs showed an annual increase of 3.2% with productivity slowing to a 2.4% annual growth rate. There is no question that Mr. Bernanke has taken the reins at the Fed and he wants to make sure the world financial markets know that he is in charge and looking forward with his monetary actions not reacting to events of the past. The fact that Federal Reserve Bank of Richmond President voted for an increase of 25 basis points is meaningless and more an indication that Bernanke wants to appear as if he is encouraging a variety of opinions.

The next Fed move

The economists who had predicted an increase in the Fed Funds rate are now predicting that the Fed will move again at the next FOMC meeting on September 20th, I will again disagree and put the odds at less than 1%. These inflation worriers remind me of an old Churchill quote: “Most economists use statistics like drunks use lamp posts: for support more than for light.” If Mr. Bernanke believed that the Fed would have to increase rates again in six weeks he would never have written the press release focusing on the need to be patient with upcoming inflation statistics. It’s also important to remember the past and when you have been around as long as I have the past is an asset that I continually draw upon to illustrate that history does frequently repeat itself, just not when we expect. At the May 20, 1997 FOMC meeting the Fed announced that it was pausing from its firming but was maintaining its bias toward future tightening. http://www.federalreserve.gov/fomc/minutes/19970520.htm. But instead of increasing after a pause the next move was actually a lowering of rates in 1998. At the June 27-28, 2000 meeting Mr. Greenspan announced a temporary pause in Fed tightening but clearly stated a concern over future inflation rates that would probably force the Fed to again increase short term interest rates. But somehow the inflation fear never materialized and the next Fed move was an ease in January 2001. So although we will be hearing from the “experts” that the Fed is pausing the most likely outcome is a 6-12 month period of Fed stability with next move coming in 2007 with a lowering of the Fed Funds rate.

Four keys to future monetary policy

It is clear that the Fed is worried about the ability of the US consumer to continue spending like they have for the past 24 months. Job growth is tepid at best with monthly increases of just over 100,000 which is not enough to create GDP growth of more than 2%. With the closure of the Prudhoe Bay oil field in Alaska the price of oil has held its $75+ level and this high price is having a negative effect on consumer spending. Yesterday McDonalds announced that July’s same store sales rose by the smallest amount in three years. With the Fed (and other world central banks) not monetizing (increase in money supply) the oil price increase the average consumer is spending more on fuel and less on other non-essential items. Another important point is that the increased revenue from oil price increases that is going abroad is unlike the 1970’s when oil producers used 75% of their revenue to purchase US items whereas the new producers are spending only 30% so the revenue stays overseas. I find it interesting that on a day when the Fed announced the end of interest rate increases the Dow Jones Transportation Index slumped to a new low for 2006. Obviously the stock managers see a distinct slowdown in freight carriers due to a slowing in consumer demand. The final part to the puzzle is housing and it has become a painful period for those trying desperately trying to sell their house or refinance their mortgage to take cash out only to find that the value of the house has stopped increasing and might even be falling……There was an excellent article in Monday’s NY Times about the growth of property tax collections running at a higher rate than the growth in personal income in many areas. This is clearly the start of a long, slow bear market in housing prices instead of the typical bull market correction that we have experienced for the past 25 years. Finally we must remember that the price of money (interest rates) is determined by the supply (Fed) and the demand (corporate & personal) and the Fed is closely watching the rate of change in commercial and industrial loans. Recently we have seen a slight drop in the growth rate but not nearly enough to give the Fed a reason to begin easing (lower rates). When, not if, we begin this descent (later this year) it will give the Fed a strong reason to begin the next cycle in Fed easing which should last well into 2007-2008.

The bleeding of the housing market has begun

Normally foreclosures are a product of a mature part of a bear market but Nevada seems to have accelerated the cycle as the 2nd quarter found one house in foreclosure for every 248 households. Texas, which has not seen the same price increases had only one house in foreclosure for every 39,690 households. With the inventory of single-family homes in Las Vegas now over 20,000 (8,000 vacant) it seems that they may be some great rentals soon to be available in this desert community. http://www.lvbusinesspress.com/articles/2006/08/07/news/news03.txt http://www.reviewjournal.com/lvrj_home/2006/Aug-08-Tue-2006/business/8937177.html

In Florida cities like Naples the situation has become desperate as it has an 18 month supply of homes on the market. The best quote of the week comes from the Palm Beach Post “The zoo is not the only place to look for ostriches these days. A lot of local homeowners also have their heads in the sand because they refuse to believe the unprecedented five year real estate boom is over.” Many of these homeowners will soon put rental signs outside of their house in a last ditch attempt to create cash flow that will be used to cover mortgage payments. With 42% of 2005 first time home buyers having zero down loans it is doubtful whether rent payments will cover their mortgage. Finally, according to the National Association of Realtors Miami now has a 17 month supply of single family homes for sale.

Florida, California, Arizona and Nevada are all states that saw massive appreciation in home prices in 2003-2006, so it is not surprising that we are seeing a softening in these markets. What is surprising is that I am seeing supply/price problems in areas like Richmond, Virginia where supply has doubled in the past year (6,500 vs 2,800). Quad Cities, Iowa now has 1,338 homes for sale which is a 17 year high. I could give more examples but it is obvious that this bear market is infiltrating every part of the US.

UK housing rebound

Mortgage approvals in England rose in June to the highest levels of 2006 and this is one of the main reasons the Bank of England raised its inflation forecast in a report released this morning (3am). Last week we saw this central bank raise its overnight lending rate to 4.75% due to its concern that UK inflation is headed for 3%. But long term UK interest rates are betting that this will be a temporary rise in inflation as the 30 year Gilt is trading at 4.25% and the 10 year at 4.68% both below the overnight rate thus making the entire yield curve inverted, very similar to the US. Today’s inflation report is over 50 pages and only should be read if the late night news/sports can’t put you to sleep. http://213.225.136.206/publications/inflationreport/ir06aug.pdf

Own a condo but pay no property taxes?

Would you like to live on the Mississippi River? According to the St. Paul Press a local contractor has created the idea of a “floating city” where for prices ranging from $275,000 to $474,000 you can own a condo that is part of four adjoining barges that will travel up and down the country’s largest river and have no permanent home. This boat? has been designed to split in half to pass through tight channels with no current laws preventing travel anywhere on the river. This idea may have succeeded a few years ago but with declining house prices and soon to be great rentals available I’m pretty sure this novel plan will soon sink to the bottom or be regulated out of existence.

Final Thoughts

Tuesday was the most important day of 2006 for those that follow interest rates. The next move or non move from the Fed will be determined by the direction and level of long term interest rates. It was really an easy decision for the Fed to “pause” because the US Treasury 10 year note had declined to 4.90% making a 5.25% Fed Funds rate tight enough for any central bank trying to fight inflation and keep the economy and jobs growing. If the 10 year rate declines to 4.50% it will give the Fed the “cover” it needs to lower the funds rate but this will only occur if the growth in GDP slows to under 2.5%, monthly job creation slows to under 100,000 per month, the price of oil stays over $70 and finally house prices begin to decline instead of just staying as unsold inventory. The tipping point to a Fed ease could easily come from the housing sector as that holds the key to a contraction in consumer spending. The ATM machine that has been accessible to most homeowners is closing down and with a negative savings rate and high oil prices the US consumer has run into a road block that they may not be able to navigate through without a new source of income or asset appreciation.

P.S.

Long term interest rates have declined 35 basis points over the past 5 weeks (5.24%-4.89%) and now may need a rest as today’s 10 year note auction and tomorrow’s 30 year auction create $25 billion of new supply. For those real estate professionals that have a short term outlook it might be a good idea to “lock” today. For those with a longer term horizon long term interest rates should be much lower later in the year offering much better opportunities to lock in lower fixed rate mortgages.

As always, I welcome any questions or comments to these e-mails and I will be teaching another interest rate class in Los Angeles in October with a specific date to be announced soon.

The checkered flag is in clear view

The job of economic and interest rate forecasting is difficult with the true superstars batting a little better than .500. Once every few years the clouds disappear and every pitch looks hittable and if by magic every swing of the bat sees ball after ball landing in the bleachers for a home run. The last four weeks have been remarkably clear for this writer and luckily our forecast of much lower long term rates has occurred and the end to Fed tightening is just a few hours away.

Before the updated forecast and comments let’s review highlights from the past few interest rate e-mails.

6-27-06 – 10 year @ 5.20% – “Hang in there, the best of 2006 is yet to come.

6-28-06 – 10 year reaches 2006 high of 5.24%

7-03-06 – 10 year @ 5.15% -” If the 10 year stays below 5.25% (as I believe it will) then we will have come to the close of a 24 month chapter of Fed tightening.” – 10 year never rose above 5.25%

7-07-06 – 10 year @ 5.13% – “We see a very meaningful decline in the 10 yr. rate over the next few months.”

7-14-06 – 10 year @ 5.06% – “Pay close attention to this rate because it is on its way to 4.85-4.90% over the next couple of weeks”

7-19-06 – 10 year @ 5.05% – “The next piece of the puzzle will be filled in on Friday August 4th with the jobs report, which I again expect to show weakness.”

7-28-06 – 10 year @ 4.99% – “Long term interest rates are headed lower with the 10 year US Treasury dropping to at least the 4.85% level.”

8-04-06 – 10 year @ 4.90% – The jobs report showed an increase of only 113,000 and long term interest rates plunged.

If you know anyone that even came close to this forecast accuracy, please e-mail me so I can subscribe to their newsletter.

This morning’s job report

Like the inveterate baseball fan who arrives at the ballpark each day to watch every minute of batting practice, I awoke earlier than usual today (3am) and eagerly drove to my office (5 minute drive) awaiting the 5:30am announcement from the Department of Labor. The report that only 113,000 jobs were created in June stunned the “experts” who were predicting much higher job growth and more importantly a continuing of Fed interest rate increases. The most incredible part was watching CNBC interviews where economists would refuse to change their forecast for Tuesday’s FOMC meeting. These soothsayers are truly like broken clocks who can only be right twice a day. Job growth is slowing due to high oil prices that are slowly curtailing consumer spending, slowing and now falling home prices that are pushing the late comers (RE agents, mortgage brokers, etc.) into the job searching market and finally rising short term interest rates are taking a bite out of the over leveraged household sector. Those that continue to confuse a bull market with brains are in for a rude awakening over the next year.

Bank of England raises overnight rate

Yesterday’s 25 basis point increase (4.75%) by the Bank of England caught the “experts” by surprise as the housing sector has found a 2nd wind. It’s important to note that long term UK rates are not afraid of future inflation. The 10 year British Treasury note is only 4.71% and the 30 year is trading at 4.27%. The BOE has one of the best credibility scores among world central banks so the inverted UK yield curve is a precursor of lower long term rates in the not too distant future.

Recession?

I received an e-mail this week from a reader asking if a US recession would change my interest rate forecast. The answer was a quick “maybe” but in reality the US economy has a few parts going in distinctly different directions. When I want to know the health of the economy one of the parts I analyze is tax collections which normally rise when business expands and contracts when the economy slows down. According to the Rockefeller Institute of Government the 2nd quarter saw tax collections for 34 states increase 10.2% compared to the same quarter in 2005. Digging deeper we found that personal and corporate income tax collections rising BUT general sales tax collections were weaker. This is not surprising as the US consumer has been over spending and under saving for the past 18 months. With the price of oil rising and more of the typical wage earner spending more on gasoline and less on non necessities sales tax collections are not keeping up with the taxes from asset sales (real estate, etc.) that are filling most states coffers.Soon the asset sales will slow and income tax collections will join the sales tax and make the states eager to find new sources of revenue (gambling?) http://rfs.rockinst.org/exhibit/9061/Full%20Text/SRP_65P.pdf

Housing

I could write for hours about what is happening in the housing market but will leave that for another day. Has any one noticed that the price of lumber has fallen almost 33% this year? Obviously builders are pulling back on projects and don’t see the need to build their inventory of lumber. This week saw many of the home builders report a decline in earnings but it is what they say with these reports that I find informative. The CEO of Hovananian said they are “renegotiating a significant number of its land options contracts which is expected to result in walkaway costs.” In other words more losses and red ink is on its way. For those looking to buy the first dip or start a foreclosure business I warn “Be Careful” the first dip will turn into a shaky cliff that many will fall from over the next few years. We have entered a long term (5 years+) bear market in housing that will surprise everyone because of its tenacity and slow painful decline. Crashes are great because they occur quickly (October 1987 stock market) and then rebound back to their old levels. Bear markets slowly bleed everyone to death with a final capitulation when the players are too worn out to continue (Tokyo real estate 1994-2004).

The Fed meeting on Tuesday August 8th

Many, many months ago I wrote that 8-08-06 would be the most important date for interest rates in 2006. Tuesday’s FOMC meeting will result in a change in monetary policy. The Fed will NOT increase the Fed Funds rate by 25 basis points for the first time in over 2 years and will release a statement at 11:17am making sure the world markets understand that this change may be temporary IF they feel that economic conditions (inflation, jobs, etc.) vary from the current range. The press has written about inflation fears and that the Fed should not stop raising short rates until they see that inflation has definitely peaked. My answer comes from a speech given last week from SF Fed President Janet Yellen: ” If we kept automatically raising rates until we saw inflation start to respond we most likely would have gone to far.” The Bernanke Fed is now operating closer to how Mr. Greenspan ran monetary policy. Tell everyone you are data dependent (rear view mirror) but always use the front window (forecast) to make interest rate decisions.

Next week

For those real estate professionals looking to “lock” loans I would use the “buy on confusion, sell on the facts” method and lock on Wednesday morning (8-09). Wednesday we have a $13 billion 10 year auction and Thursday a $10 billion 30 year auction and history has shown that a bond market that rallies into auctions usually finds that supply wins with interest rates rising for at least a few days. For those with a longer time horizon, long term interest rates will resume their downtrend later in August before reaching 2006 lows later in the year.

Enjoy the ride….its been a great 4 weeks for those that follow these e-mails.