1) How will we know when the QE2 trade is over?
It’s about that time when the smart money is beginning to think 10 moves ahead in the chess game. And in this game, the only piece worth focusing on is QE2. QE2 ends on June 30th and traders are already jockeying for position. How soon will the QE2 trade end? No one can tell. It could be a sell in May or it could be a sell the news. But one thing will be very clear when it occurs – the US dollar will stage a counter-trend rally.
One of the primary fuels during this speculative fervor has been the decline of the dollar. With the exception of a brief period in November no sector has benefited more than commodities. As I’ve previously discussed, this hasn’t generated some great economic benefit for the United States (that wasn’t already occurring), but it most certainly has translated into speculative behavior.
The dollar’s decline was relatively benign until the ECB began forecasting rate hikes earlier this year. And the usual inverse correlation can be seen in a sizable Euro rally. The end of QE2 will be seen as a pseudo form of tightening and a step in the direction towards US rate hikes. This could be an excuse for short covering and a USD rally. And while that doesn’t necessarily mean the commodity bull market is over it is likely to put a dent in the QE2 trade.
When currencies converge?
When will it happen? As I mentioned above, the timing is impossible to know, but if I had to venture a guess I’d say we’re closer to a EUR/USD bend in the trend as opposed to a continuation of the trend. And we all know what they say about the trend and friends….
2) Collapsing lumber prices portend a weaker economy?
Did you completely miss the utter collapse in lumber futures in recent weeks? I certainly did. In just the last 3 weeks lumber futures have fallen 25%. The Wall Street Journal says the decline has been due to a number of factors including fears of slowing Asian demand, weak US housing markets and excess supply:
“The recent decline in lumber futures was blamed on increased first-quarter mill production that met stagnant domestic demand and exports that were strangled by shipping bottlenecks.
China emerged last year as a dominant buyer in western U.S. and Canadian lumber markets. Mills responded by ramping up production to meet export demand and take advantage of an expected seasonal surge in U.S. house construction as spring arrived. Yet shippers couldn’t keep up with export sales to China and the spring housing demand failed to materialize, creating an oversupply problem that fueled the selloff, which started late last month.
…Despite the growth in Chinese demand, the U.S. remains the top market for North American lumber, so when the U.S. housing market is dormant, lumber futures prices soften, said Jamie Greenough, a broker and lumber market analyst at Global Securities Corp., a securities and commodities brokerage in Vancouver, B.C.”
Lumber prices have had a very close correlation with the US economy. While prices appear to have stabilized in recent days you have to wonder if this isn’t a sign of more serious weakness overall. One thing is for certain – the US housing market remains mired in a deep recession.
3) Why does the cost of a house get such a bum rap?
Whenever I talk to someone about inflation in the current environment and I tell them housing costs are near their lows they always reply: “sure, but I don’t buy a house every month”. Well, that might be true, but most Americans pay their mortgage every month – so you kind of do buy a house every minute of every day if you think of it in terms of the duration of the loan. Unless you paid in full upfront (which most homeowners don’t) you’re in a persistent state of buying the home. You could actually argue that you buy your home more often than you buy anything else because you can be damn sure the bank is calculating their loan value by the millisecond. Okay, that’s an exaggeration, but why do people downplay their largest monthly expense?
With interest rates near all-time lows mortgage refinancing is very beneficial – even after the recent rally in rates. In addition, new buyers are swooping in at a 30% discount in the real estate market. In essence, homeowners are able to lock-in deflationary prices in the current environment. That’s a significant price decrease for a vast majority of Americans. While many other prices are rising, housing has rarely been more affordable. Some recent charts from Liz Ann Sonders at Charles Schwab put this into perspective:
It’s no coincidence that the Housing Affordability Index troughed with inflation in the 70′s!
Inflation?
The moral is, the cost of owning a home has plummeted in recent years and this accounts for the majority of one’s monthly non-discretionary spending! Whether you are looking to purchase a home or have an old mortgage you are able to take advantage of significant deflation in your largest monthly expense. This isn’t an attempt to downplay the damaging impact of inflation in other markets, however, when assessing the bigger picture it is very important that we keep things in perspective. According to the BLS, housing related expenditures account for 47% of total consumer expenditures. The price you see on the gas sign every day isn’t nearly as important as the one you see on your monthly mortgage statement. And there is absolutely zero inflation in that payment.
These 3 things never disappoint.
USD.EUR -> another psychologically driven nonsense trade like the QE trade, since the EUR money supply is/ will be way tighter than the USD supply. + demand for EUR is increasing due to the debt crisis, in combination with the inability of europeans to monetize deficit spending! + demand in USD is shrinking due to increasing destructive deficit spending, + more and more countries trying to trade in other currencies than the USD.
That should be a cushion for a continuation of the EUR rise. But since flawed mainstream consensus is, indebtedness -> falling currency, there might not be the cushion.
A few thoughts I had after reading this article. I don’t disagree that there is zero or even negative inflation in the housing payment, but I don’t think it helps the majority of people as much as you would think.
1. The cost of the house gets such a bum rap because most people “brought” the housing asset during the bubble. Since houses are a leveraged and relatively illiquid asset, most homeowners are unable to benefit from rising or falling prices in housing.
If the price of the house decreases, the average homeowner does not and cannot see the benefit of reduced monthly payments because they are unable to refinance. This occurs because a large percentage of homeowners are upside down on the house or behind on payments. This is without taking into account homeowners who have bad credit, negative amortization loans, ARMS, home equity lines.
Note that the last three causes actually increase the monthly costs of housing — a net deflationary effect.
2. In some markets, I would argue that affordability has not yet hit a bottom. I believe Cullen that you reside in the State of California. I know for a fact in LA, Orange County, and the Bay Area that house prices have yet to dip below the beginnings of the bubble in 2002-2003.
I would also argue that rising rates will further deflate the cost of homes as the price of the asset becomes harder to finance — and thus sustain — since housing is the most leveraged financial transaction that the average American will make in their lifetime. However, Proposition 13 makes this beneficial to future buyers since the property tax is almost fixed as a percentage of the purchase price. This creates the incentive (at least in California) to wait to purchase housing when financing is costly and the asset price depressed. It is a net deflationary effect on housing prices.
3. I do agree that inflationary concerns are mostly overstated. I would argue that the real danger of continued low interest rates is not inflation, but rather deflationary effects that can occur as a result of leveraged malinvestments. In fact, one only has to look at increased mergers and acquisitions — and the layoffs that often result from such activities — to see the deflationary effects that can occur from low rates.
Agreed On #1 Wulfram RE is more a balance sheet issue for homeowners – not a daily expense. Actually with a lower valuation and similar monthly payments – the payments are inflationary vs the lower valued property.
Cullen: Point 1 timing: difficult to know, that’s right. For QE1, the trade begun 2-3 month after the beginning of the program, and ended the exact day it ended. For QE2, the trade begun 2 month before the official announcement of the program. This time, everybody is sure to be long to end June (just need to take a look at investor’s letters or blogs).
Do you remember the paper from Nomura i send you, about the “bubble learning experience”? The conclusion was: ” the second time, market participant will go out of the market before they were for bubble 1″. Bottom line: smart money will anticipating the end of QE2 this time.
If you take a cross market and asset look, you can see huge distribution patterns on DM index, as well on EM markets, and commos (excepting the booming precious and oil). I will not bet of a “mai 2010 bis repetita”, but right now, the risk is clearly asymmetrical for the long un-hedged…
if you think there is going to be any serious tightening in US monetary policy in the run up to a presidential election, i own a bridge in Brooklyn i can let you have for a modest sum.
Actually, there is inflation in my mortgage payment–I just received the notice this month that my monthly charge was going up. Why? Because my property taxes and insurance are escrowed–and the bank increased my payment roughly 3% to cover them.
The mortgage payment may not increase, but that doesn’t mean the costs of homeownership won’t (especially if the chatter about limiting the mortgage interest deduction comes to fruition). When you buy the house, they have you trapped. . .
Probably because not everyone has been able to refinance due to negative equity. The cost of housing hasn’t decreased even if homes prices are lower.
three things always a must read.
man, am i glad i built my place myself with cash.
boatman refuses to rent money…..only thing i rent is beer.
rising ECB rates n fact 95% of spainish home owners have quickly reset variable interest rates and spain was the european leader in the housing bubble in europe means goldmans wrong–they will be bailed out…..hpow’s that workin’ out for greece per now 13% bond rates?…..hey-oooo
Great stuff Cullen. I still have no idea how you run this site, run a biz, and run a life. If you have kids, I’d probably start to ask if there are two of you:)
I try to understand as much as I can about the Chinese economy and it seems to me they are at the very early stages are slowing down. Although everybody has been saying that for months so it is really tough to predict. They seem to hold the key to commodities. QE2 will play a role too and you just never know how much speculation is in the current price. Realizing futures are very leveraged, I wonder if we get another huge spiral down that overshoots to the downside as forced liquidation takes place.
Well, I’ll be honest. Before I started the website I used to read research all day. I am not a really active trader so while I keep tabs I am not frantically doing anything. So, now that I have the site, I just write about what I read about. To be honest, not much has changed since before. Except that I have thousands of really smart people I can bounce ideas off of now. I am not lying one bit when I say that one of my favorite parts of this site is reading the comments and interacting. I have learned more than any of you could possibly know and it’s because of the incredibly smart people that come here and critique the posts every day. I am really greatful.
Cullen, I believe I speak for many readers when I say I would like to express my profound appreciation for your pragmatic approach to discovering truth in the world and helping others benefit from your wisdom. You prove to me on a daily basis that you are wise and intellectually honest; we need more like you in this complicated world. Thank you!
I’ve always felt that inflation is to a large part a function of ones income and is not felt in the same way evenly by everyone. The higher your income, the smaller percentage of that income is spent on food, fuel, medical etc., and this is where the price increases are occurring. Contrast this with someone in a lower income lever or those retired with a modest savings living on a pension and or Social Security. By the time they pay the house payment and car payment there isn’t much left to begin with and these price increases be it food, fuel, medical or whatever although they may be somewhat small in the big picture are a larger portion of their total income and a big deal to them as it ravages what is left of their disposable income. In their situation inflation is being felt on almost everything but their house payment Unfortunately for many of these people their house payment is in fact fixed as they have refinanced their home years ago. I know that in my case I refied about 10 years ago at about 5.5% and although I didn’t catch the bottom tick in rates, the additional drop in rates really wasn’t enough to justify refinancing again. Many people I know are pretty much in that same situation and I suspect this could apply to many who lived in the same home for ten years or more. I would guess many of us who follow the financial markets and frequent these sites aren’t in the same situation income wise and don’t see things in the same way as those in the lower 50% income level do but it is at least something to consider.
One of the positives it seems to me is that the decline in home prices is really a huge longer term positive for those who will be, over the coming years, purchasing their first home. This seems to be largely overlooked but for the younger generation with no current rent expense but who will be looking at it in the not to distant future, although they may not realize it now, deflation is alive and well and could end up being a big positive towards their future cost of living.
HMMMMM!
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