FMX | Connect – www.fmxconnect.com - (Reported 6/24/2010)
Excerpts from MARKET MUSINGS & DATA DECIPHERING
MARKET COMMENT
Perhaps it wasn’t unusual to see new home sales trail off in the aftermath of the expiry of the housing tax credits but the magnitude was very surprising. Moreover, since mortgage applications for new purchases through the first three weeks of June are a huge 15% below May’s tally, this massive slump in home sales is not exactly a one-month wonder either. New home prices are down 10% year-to-date and one has to wonder whether yesterday’s message in the post FOMC press statement was the first hint of an eventual return to quantitative easing.
As for the markets, everything seems to be bouncing off the 50-day moving average – the S&P 500, oil, and the U.S. dollar. The stock market is down 2% for the year in what looks to be a very important topping formation. That was not expected at the start of the year, that much is for sure.
The really big story is in the bond market. The yield on the 10-year T-note yield and the long bond, after yesterday’s rally, is down to levels that are below those prevailing when the Fed was busy building the firewall against deflation back in mid-2002. Back then, the Fed cut rates (75 basis points during that borderline double-dip), the government could cut taxes, and for good stimulative measure, go to war. And of course, we had Congress turn a blind eye towards the credit excesses that provided further juice with leverage ratios among Wall Street banks and the GSEs that ranged from 30% to 70%.
Look at what we have today: No room to cut rates. No room – let alone ideology – to cut taxes. And, in contrast to starting a new war, the U.S. is going to be pulling troops out of Afghanistan, which is a good thing for the troops and their families, but in terms of GDP impact it does represent fiscal withdrawal. The options to resuscitate the economy when it – no longer an if – enters a 2002-03 style growth collapse are extremely thin. And, they probably lie on the Fed’s balance sheet, which means the bond-bullion barbell will likely remain a viable strategy.
At current yield levels (1.9% on the 5-year?), the Treasury market is screaming deflation. If it is right, not only is the consensus estimate of a new peak in corporate earnings in danger, but so is the key 1,040 technical threshold on the S&P 500.
FED TAKES DOWN GROWTH AND INFLATION VIEW
At the margin, the Fed changed just enough of the wording in the press statement from the April 28 release to suggest that it is in the process of taking its growth and inflation forecasts down. Whatever anyone’s time horizon was on the Fed’s first funds hike, at this point, it can safely be pushed even further into the future. Perhaps even as far out as 2016. A recent San Francisco Fed study strongly hinted that we will be past 2012 by the time the Fed raises the funds rate. The study also made the point that even with the funds rate basically at zero and the Fed’s balance sheet bloated at over $2.3 trillion, overall policy is still 300 basis points too tight in light of the pace of economic activity, the size of the output gap and prevailing trends of underlying inflation. That is what we are penning in; understanding that we are in uncharted territory and that forecasting the Fed is more an art than a science, even at the best of times.
The Fed no longer sees the recovery as a “continued to strengthen” backdrop but that it is “proceeding” (growth but it is slower) and the labour market is no longer in “improve” mode but is “improving gradually” (that is not good in the context of a double-digit unemployment rate). Note that back in April, it was “growth in household spending” that had “picked up”, which is an improvement in the second derivative; now it is merely “spending is increasing”. Again, the subliminal message here is that we are in deceleration mode.
THE ROOF COLLAPSES ON THE HOUSING MARKET
New home sales cratered a record 33% in May, to a record low of 300,000 units at an annual rate. This breaks the prior all-time low of 341,000 set back in April 2009 when the economy was knee deep (more like six feet under) in recession. There must have been a wave of cancellations too because April was revised down to 446,000 from 504,000 and March to 389,000 from 439,000. The only other time when new home sales made a new low 11 months after the end of a recession was during the double dip of the early 1980s – assuming that the pundits are correct on this assessment of when the economy bottomed out.
This wasn’t just an oil spill or weather story either as every region posted a huge decline. All the tax credits did was play around with human nature – all the government intervention could really do was distort the data and delay, but not derail, the fundamental secular downtrend in residential real estate activity. The inventory backlog, which had taken a dive in April as the tax credits were about to expire, soared from 5.8 months to an 11-month high of 8.5 months. And, this excess supply is exerting more downward pressure on pricing – the median price of a new home fell 1% MoM in May to $200,900 and is now down nearly 10% for the year (was $222,600 in December). Home prices have not been this low since December 2003 and are light years away from the $257,000 peak established in mid-2006.
David A. Rosenberg
Chief Economist & Strategist Economic Commentary
drosenberg@gluskinsheff.com
+ 1 416 681 8919
Source: Market Musings & Data Deciphering
http://www.fmxconnect.com/
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