We are excited to partner with one of our favorite mortgage minds, Lou Barnes, to bring you his biweekly commentary. Lou is a loan officer in Boulder, CO, but his insight is relevant across the country. Lou's opinions should not be construed as the opinions of CENTURY 21 Redwood Realty or our partner, Day 1 Mortgage.
Game on. The US Fed versus the global economy and markets, and a long line at the recession betting window.
New Data. Today’s employment report is still healthy, 372,000 new jobs but a quarter of that figure revised down in prior months. Wage increases have decelerated to normal: from 5.1% in the last year, in June down to 3.7% annualized. “Leisure and hospitality” up 8.4% in the last year, while high-pay “information” jobs only 4.2%.
The ISM survey of June service-sector logistics found 55.3, okay but steadily declining from the 12-month average at 60.8.
Measures of job openings are still sky-high, as is the “quit rate,” normally indicating overheating -- but today more likely effects of our economy’s IT transformation, magnifying both skills mismatch and opportunity, not an inflation-driver. Nor is our low unemployment rate a driver -- we have a worker shortage that we are not used to, which in time will respond to automation, immigration, and trade.
Give Thanks For Chair Powell. Perhaps the toughest part of a Jesuit education: having to spend the rest of your life in doubt, especially suspicious of things which you think you know. Powell in Europe last week: “We now understand better how little we understand about inflation,” a remark which enraged those who are certain that they understand.
Closed minds are upset that old causes and remedies are obsolete. Low unemployment is not a cause, nor raising it a remedy. The cost of money need not rise to “real” over inflation because prices themselves rising twice as fast as incomes are suppressing demand.
Powell shows active observation and revision every time he speaks. Last week he described supply and demand shocks -- at Covid outbreak demand for autos “straight up” because people didn’t want to ride public transit, but “in principle, at least, that process can also work in reverse. When demand comes down, inflation could come down more quickly.”
That good thought describes the Fed’s greatest risk. What to do if CPI/PCE begins to go negative in recession?
Market-Fed Collision Ahead. The Fed meets again in 19 days and will likely hike the cost of money by .75% to 2.50%. Markets don’t care. Nor will they care about another .50% to 3.00% on September 21 -- so long as the Fed then signals an extended pause. Which will be hard to do, unemployment likely unchanged, and inflation down but not out.
The 2-year T-note ran up to 3.42% last month, a forecast of a cost of money cycle-top near 3.50%, similar to the Fed’s dot-plot in June. The 2-year then promptly fell back to 2.83%, saying all-done at 3.00%, that drop encouraged by the commodity collapse. The whole yield curve fell down to 3.00% or below.
This week, hawk-chirps have pushed the Treasury curve back up and changed its shape. The “belly of the curve,” maturities 3- to 7-years all pay more than the 10-year. Not much, but inverted. The hawks this week are unreliable: ego-blimp Bullard, and new governor Waller, personally battered by selling his St. Louis home and unable to buy one in DC.
The Fed key between now and September will be reports of inflation. I do not know a source reliable in forecasting the pull-through of commodity collapse to CPI/PCE. Natural gas down from $9/mbtu to $6 will drop prices for everything from utilities to fertilizer. Gasoline futures from $4.25 to $3.45 will knock retail back to four bucks. (Memo to Crabby Joe: if you had worked a day in your life in a merchandise business, you’d understand first-in-first-out inventory, gasoline included.)
Housing and Recession Bets. The most confusing single aspect of recession: housing faints several to many months before recession onset, while the worst moment for jobs trails housing by a year or two, usually marking the end of the recession. Charts below, housing starts versus claims for unemployment insurance. In the era of Phillips Curve, too-low unemployment was the inflation determinant, hence the Fed stayed tight long after necessary. Today, the rate of unemployment may not matter, merely collateral damage.
Housing... I am not confident that the Fed understands, and look forward hopefully to Powell comments someday. Meanwhile... the Fed in late June published “Volatility in Home Sales and Prices: Supply or Demand?” , a 59-page lesson on how not to do research. Nifty formulae, an invented vocabulary for PhD cognoscenti (“sale hazard rate”), the perfect ivory tower construction of an alternate universe. It’s primary conclusion: the number of home sales has nothing to do with supply, just demand. If the authors tried that on any group of near-urban real estate brokers today, the last two years an ocean of buyers and nothing to sell... oh, my. Possibly the authors meant to say supply of new construction. They did acknowledge that tight markets lead to higher prices. (Another memo to Joe: if you cancel student loans... not for these authors.)
One possibly useful alleged datum: a one-percentage-point increase in mortgage rates cuts demand by 10.4%. Just curious... what about the next one point up, especially if following the first in three months? And the next? A linear additive effect, or compounding?
China. Given censorship the best we can do is inference. Xi wants to be anointed emperor for life at the Party meeting this fall. The Party’s covenant has been economic infallibility, citizens to stay out of politics. The Q2 collision with stupid-Covid policy has probably produced negative GDP beyond the Party’s ability to conceal, and Xi’s assertion of 5.5% 2022 a ridiculous loss of face.
Li Keqiang, #2 and successor shoved aside by Xi’s ambition suddenly surfaced during the Shanghai shutdown, raising economic alarm -- emergency alarm. He did so again this week, after the Party floated a $220 billion bond sale by local governments for more sugar-high infrastructure stimulus -- which given the collapse of property development, local governments have no revenue for bond payments. The best of China’s economy is hollowing, exporters abandoned in favor or more secure suppliers. All of this money for the military, for “belt and road,” for the tens or hundreds of millions of anti-productive people in hazmat suits and the security/censorship apparatus... where does all the money come from? A crypto-quality pyramid of debt?
Ukraine. Vladimir will not stop until he cannot continue. He has no personal or cultural restraint, no matter how heavy his casualties. Our fear of his possible escalation gives him a free hand. We have let down Ukraine, given promises and then slow-walked support. And let down ourselves. Ukraine will not fight a losing battle of attrition forever.
Borisexit. US coverage of Mr. Johnson has been distorted. George Bernard Shaw: “Two peoples separated by a common language.” The UK suffers from class, like caste; Johnson is pure Oxbridge upper-upper (see “Chums”), despised by Labor and US Lefty press. The Left there and here never got over Brexit, nor their preference for one-Europe goop, nor short-selling the benefits of sovereignty and one’s own currency and freedom from Brussels. Johnson failed in perfect upper-crust style, unable to suppress eccentricity and contempt for the rules abided by common citizens. BTW: the happiest at his demise is Vladimir (Johnson shared Sir Winston’s understanding of Russia), and the saddest is Ukraine. BTW2: after the next UK midget gives it a try, we’ve not heard the last from Johnson.
The 10-year T-note in the last 90 days. The Fed’s jawbone terrified 10s in June; recovery followed commodity collapse. No matter what the Fed says or does, 10s will trade on hints of recession:
The 2-year, same pattern, but 2s will be forced up by Fed hikes and post-hike talk. If the Fed as hawks insist plans 3.50% by year-end, 2s must go there. That’s why inversion -- 2s above 10s -- now seems inevitable. Only favorable CPI/PCE prints will stop it -- or perhaps Chair Powell’s deep reservoir of common sense:
Here is a series of charts of prior recessions, labelled by year. Housing starts in red, claims for unemployment insurance in blue. The first is 1973-1975, the first oil shock:
1979-1983, the weird double-recession, the second oil shock, but the patterns the same:
1989-1991. No oil problem, or inflation -- an accidental credit crunch and the first recession of the new, deflationary era. Mortgages before in the teens, afterwards stable 7%-9%, hence shallow housing recession:
2000-2002, the first deflationary recession. Crashing interest rates favorable to housing:
2006-2012. As wild as the credit bubble was, a very familiar pattern. Housing rolled over two years before the peak of job loss:
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