Wednesday, June 28, 2006

Recession 2007! ... ?

How many economists does it take to hit a moving target?

The financial and economic communities are abuzz with tension right now, as the Federal Reserve is undoubtedly fine-tuning the structure of their remarks in tomorrow's policy meeting. A few weeks ago the markets were betting heavily on this meeting to be the first where the Fed did not raise rates since they began the current tightening policy in June of 2004. As I have mentioned before, the CPI numbers have been supporting the notion that inflation in the US economy is uncomfortably high. And for the last several weeks, the Fed Governors have been popping up all over the place, like a giant game of Whack-a-Mole, peppering the news with one common sentiment: Inflation persists, and is of current concern to the US Federal Reserve.

Its a different picture than a few weeks ago. This whip-saw reading on the economy is unkind to the markets, which have seen a consistent down-turn accross asset classes in the past month. Whether this is a modest correction or a trend reversal is yet to be determined. So is the economy slowing down? Is inflation still too high? The worst case would be "yes" to both.

We sit today with the markets 100% convinced that rates will be hiked tomorrow, 0.25%, to a Fed Funds rate of 5.25%. Some believe we could see a more definitive move to 5.50%. More think we will see 5.50% in August. And some think the 'terminal rate' will be as high as 6.00%.

What does this imply for our economy in the near future? As usual, there is a rainbow of opinion out there right now, ranging from healthy to worrisome. But its not the same old boom-time we have seen in recent years; current forecasts mention words like Recession, Stagflation, Asset Bubbles, etc:

  • Along with the Fed, other central banks in the world are tightening, taking liquidity out of the system. The Bank of Japan has had a huge impact recently, to the tune of some $200 billion over the last few months according to George Soros. This is in the process of throwing a cold shower at the global economy.
  • Commercial banking guidelines remain very liberal, but the tightening of liquidity on this level will be the likely next step, according to John Mauldin. Goodbye easy institutional money, and goodbye easy consumer money. How can we continue to spend and propel the economy at this pace?
  • The folks at Northern Trust provide some discourse on the inverted yield curve, and second-guess the popular notion that 'this time it's different' with respect to the yield curve / recession correlation. Hints of the Fed going too far and causing economic damage here.
  • Stephen Roach suggests that the central bankers view the recent market slowness as a correction, and are still interested in slowing the economy to a more moderate pace. Everything looks healthy; we needed this.


So lets add these ideas up a bit. Rising rates & shrinking liquidity, slowing housing markets, tightening lender guidelines... all of this has to cool off the housing market. It has to. It does not guarantee a decline, or correction in housing, but it certainly makes the idea of investing in real estate one where the risk/reward balance has shifted more in the direction of risk. The growth rate cannot be sustained, and we are seeing some hints of this in recent housing data.

It is often argued that real estate is a unique investment, in that a home both an asset, and a place to live. I support this concept, and believe that especially in the long-term view, you cannot go wrong. The media has been talking "Real Estate Bubble" since 2000. If you got scared off then, you missed one heck of a run...

Just some things to consider in the face of an increasingly gloomy economic outlook. Its a moving target. The next few months CPI, GDP, Employment and Housing data will all be interesting to watch, and should provide for further speculation, and hopefully some increased clarity on what comes next.

Wednesday, June 14, 2006

Bubble, Inflation, Fed, Recession

To get a handle on where the economy is headed exactly is nearly impossible. I am always amazed at the volume of data available and the number of analysts who all look at the same data and come up with wildly different projections.

Today's Consumer Price Index (CPI) came in showing inflation growth a little higher than the market expected, and the bond market is having a fit over it. This all but guarantees another Fed rate hike for the end of June, and the bond market is adjusting to this ahead of time.

Many economists seem to feel that the Fed historically goes too far when tightening rates, and many believe that we could wind up in a mild recession by the end of the year or early 2007 if they push it any further. Financial markets were clinging to the idea that the Fed would go on 'pause' as of the last rate hike, but today's news is changing the outlook. Ben Bernanke has to be aware that inflation is a lagging indicator, and today's news reflects 6-24 months ago's economy, but as the new chairman, he also faces political pressure to appear vigilant in fighting inflation, hence the expectation of another adjustment.

What this means is, if you are going to do something soon, you might consider locking in pricing before it gets any worse. However, I would be hesitant to pay too much up-front for the transaction, since a sputtering economy means that rates should come down again in the next few quarters. If today's refinance objective is to consolidate debt and lower payments, then don't wait. But if the Fed goes too far, the odds increase that you may find an opportunity to obtain better rates & terms in the coming months.

If you have questions about how to navigate this market, and make mortgage decisions right now, or about what this chart above means exactly, please email me.

* Graphic courtesy of Mortgage Market Guide