Housing remains a weak spot in what otherwise looks like a fairly broad improvement across the US economy.
As evidence continues to emerge that US labor markets are gradually healing and wage growth is starting to stabilize (see story), market participants as beginning to consider the possibility that inflation in the US has stabilized, albeit at low levels (see post). Other signals seem to pint in the same direction.
Outside of China-driven raw materials weakness, commodity prices are off the lows and rising, though remain at depressed levels relative to the past five years.
|DJ UBS Commodity Index|
Americans are starting to pay attention to rising prices, particularly as some of the more visible commodities such as coffee or gasoline become more expensive.
|June 2014 gasoline futures (RBM14) (source: barchart)|
This sentiment is reflected in the rising Google search frequency for the word “inflation” and will likely show up in the surveys such the UMichigan inflation expectations over the next few months.
|Google Trends: search term “inflation”; United States search only|
The markets are starting to take notice. The latest TIPS auction showed a sudden increase in investor demand.
Bloomberg: – The U.S. sale of $18 billion in five-year Treasury Inflation Protected Securities drew the strongest demand ever from a class of investors that includes foreign central banks.
Indirect bidders bought 58.4 percent of the securities at the TIPS sale. That compared with an average of 42.3 percent at the past 10 auctions. The bid-to-cover ratio, which gauges demand by comparing the amount bid with the amount offered, was 2.7, matching the highest level since December 2012. The notes sold at a yield of negative 0.213 percent, below the negative 0.162 percent average forecast of five of the Fed’s 22 primary dealers in a Bloomberg News poll.
“The stats were off the charts,” said Stanley Sun, a New York-based strategist at Nomura Holdings Inc., a primary dealer, said in a telephone interview.
The five-year breakeven rate (a rough measure of implied inflation expectations) jumped as a result.
Clearly we’ve had these “false starts” in the past, just to end up staring in the face of disinflationary pressures. But this time conditions seem to be in place for a sustainable stabilization in the rate of inflation.
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Home prices in the UK continue to rise to new highs, exceeding the pre-recession peak. The price increases started in London and have now spread nationally. Many families are quickly being priced out of the housing market. Some are calling it a bubble.
The Guardian: – UK house prices continued to accelerate in February, rising by 1.9% during the month and pushing the annual rate of inflation to more than 9%, according to the latest data from the Office for National Statistics.
Commentators warned of a “superbubble” and said the market was “out of control” as the official figures reported year-on-year prices rises of 17.7% in London and said first-time buyers had experienced double-digit price growth.Just to put this in perspective, US home prices are now roughly at the levels they were a decade ago. UK home prices have risen over 40% over the same period.
Many are blaming the Bank of England’s so-called FLS (the Funding for Lending Scheme - see overview) for flooding the market with cheap mortgages. Indeed the program has resulted in lower bank financing costs and lower mortgage rates.
But is all this cheap credit creating a speculative housing bubble in the UK or is there another factor at play? If you speak with British realtors, they tend to have one major complaint in common. The UK is facing a housing shortage as the post-recession home construction activity remains subdued.
|Source: Department for Communities and Local Government|
Homes are being built at about half the rate needed to meet the pace of British households creation. But that is also partially the case in the US – so why such a divergence in house price trajectories between the two nations? The answer, according to Goldman, is that unlike the US and some other nations that went on a building spree during the bubble years, the UK was facing a housing shortage even before the financial crisis. The UK housing “bust” happened without the “boom”.
GS: – And, while the shortfall in house building has become more acute in the years since the financial crisis, the rate of house building was also inadequate before the crisis. Unlike countries such as the US, Ireland and Spain – where house building rose sharply in the years leading up to the crisis – the UK has experienced a post-crisis bust in housing supply, without having experienced a pre-crisis boom.
But with housing prices rising faster than wages, doesn’t it mean that this rally should be ending soon? Not necessarily. The acute housing shortage has put a similar upward pressure on rents as well, limiting housing options.
And while fewer people can purchase a home after the recession, those who can end up paying materially less on their mortgage than they would be paying in rent (thanks to FLS). They are jumping into the housing market and driving up prices.
Of course if the Bank of England pulls the plug on FLS, home price increases are likely to slow. The housing shortage however will still remain, resulting in higher demand for rentals. Whether paying more for a home purchase or paying a higher rent, one thing is clear: UK residents will be paying increasingly more for shelter in the years to come.
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Some analysts are beginning to suggest that inflation in the Unites States may have bottomed. As discussed earlier this years (see post), US inflation indicators were pointing to the lowest rate since 2009. Are the global disinflationary pressures going to push the rate of price increases in the US to new lows or have we hit the bottom?
First of all, what is the market telling us? Market expectations of future inflation remain subdued, with the so-called breakeven (implied from TIPS) rates still near the 3-year low.
|5-year breakeven rate (source: Ycharts)|
The situation with consumers is similar – inflation expectations remain low relative to historical data.
With expectations at the lows, why are some analysts calling the bottom on inflation in the US? Here are a few reasons:
1. Looks like producer prices are showing signs of life, as the latest PPI figure came in above expectations.
The index has recently been changed to include a larger swath of the economy and it was those newer components which showed increases.
GS: – Headline producer prices rose 0.5% in March (vs. consensus +0.1%), while core prices rose 0.6% (vs. consensus +0.2%). The largest contributor to the unexpectedly large gain was trade margins—an implicit profit measure—which rose 1.4%. Within this category, there were large gains in flooring (+8.1%), chemicals (+4.7%), cleaning supplies (+4.0%), and apparel (+3.3%). The stronger March figures in this category followed a 1.0% decline in February, which pulled the core PPI down to -0.2%. The PPI for finished goods ex-food and energy—the “old” core PPI—rose a more typical 0.1%, consistent with subdued pipeline inflation.
Nevertheless this increase got some people thinking.
2. Today’s CPI increase was also firmer than expected (see story), a great deal of which was due to rising costs of shelter and food (not great for the US consumer).
3. In spite of the weakness in some commodity prices driven by China’s slowdown (see post), commodity indices are generally off the lows.
|DJ UBS Commodity Index|
|CRB BLS Spot Commodity Index (source: Barchart)|
In particular, the energy sector has come to life recently, with both gasoline and natural gas prices on the rise.
4. Some senior Fed officials are beginning to talk about inflation bottoming out (could of course be wishful thinking).
James Bullard: – “One thing you can say is that while inflation has drifted down … it kind of bottomed out in the past nine months, and I think it’s poised to go higher, back towards our target”
Given the data thus far, it’s difficult to make a reasonable projection at this point. With low inflation priced in however, any turnaround will take the markets by surprise.
From our sponsor:
According to the Conference Board, disinflationary pressures are not limited to the Eurozone and can be seen across a large number of the “developed economies”. The so-called “Harmonized Indexes of Consumer Prices” or HICP (a measure of inflation that has been standardized based on the EU definition) seems to show consumer prices weakening broadly, with only a couple of exceptions