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Good morning. Ethan and I, like much of the rest of the world, are looking nervously toward the Ukraine, hoping diplomacy works and wondering what will happen if it does not. But as we had little new to add on that topic, we focused on the US economy instead. Email us: [email protected] and [email protected]
House price inflation
One of the worrisome things in last week’s inflation report was a tick up in rent. CPI rent rose 0.5 per cent between December and January, up from 0.4 per cent the previous month. The pre-pandemic trend runs something over 0.3 per cent.
Part of the reason that this quite small increase in rent inflation threw people may be that it took place against a background of very high house price inflation. Surely, given that house prices are up 30 or more per cent from pre-pandemic levels, rents are not far behind?
Maybe. Dallas Fed economists have argued that “house price growth historically has been useful when predicting the inflation rates” of rent and owners’ equivalent rent (OER is the survey-based estimate of homeowners’ housing costs used in the CPI calculation). We have looked at their chart of this before:
There probably is a link between house prices and rents, but I am not certain that it is very strong, or which way the direction of causality runs. We think it is corporate profits that influence stock prices, not the other way around. Why should it work differently with rents and house prices? Robert Shiller has taught us that stock prices are much more volatile than profits. The same is true of home prices and rents:
Even if we conclude that rents follow house prices, and not the other way around, rents are not going to rise as much as prices have.
But house prices are important all the same. I would speculate that they have an important effect on people’s perceptions of inflation, and thus play a role in today’s (wretched) consumer sentiment. At the same time, high house prices surely create wealth effects, and if prices have risen to unsustainable levels (as some people argue) a reversal could dent today’s (strong) consumer spending.
So what do we know about house price inflation? According to the National Association of Realtors, the median US house price is about 15 per cent higher than it was a year ago, and 35 per cent higher than it was in pre-pandemic January of 2020. The great Covid-19 house upgrade cycle appears to have stalled, and prices peaked, this summer. Chart from the NAR:
(It should be noted that this aggregate number conceals a split. More expensive homes are still rising rapidly in price, while those under $500,000 are seeing prices decline.)
The pause in median prices would be better news if, at the same time, people were still buying and selling a lot of houses. But they are not. Here is existing home unit sales:
Part of the reason that people aren’t buying a lot of houses is there is not very many of them for sale. The inventory of existing homes, which has been in long-term decline, has plummeted since the pandemic began:
It is hard to see house prices falling off a cliff when there are so few of the damn things to buy. This is the reasoning of Rick Palacios of John Burns Real Estate Consulting. He thinks house price increases will cool next year, but only into the high single-digit range. This, despite 30-year fixed mortgage rates increasing by about a percentage point, to 3.7 per cent, from the lows they hit last summer. Palacios argues that the while higher rates will drag prices, they will also contribute to scarcity of inventory. He reckons that about 30 per cent of homeowners have mortgages below three per cent on their current homes. If they moved now, their new house would be expensive, and they would pay more to finance it.
What happens next? Much higher rates, especially combined with a cooler economy, could break the current high price/low inventory deadlock. Barring that though, the status quo looks stable.
There is one complicating factor: homebuilders. They have been enjoying incredible demand and pricing, and have been buying land for houses, as Palacios puts it, “hand over fist”. Yet labour and materials shortages have meant the houses have been slow to be built and delivered to buyers. As a result, a lot of new homes might hit the market late this year. The total number of new housing units either authorised for construction or awaiting completion has surpassed pre-housing crisis highs, as this chart from John Burns shows:
Think of it this way: 1.75mn new houses are on their way, when there is only about half that number of existing units for sale. The US, broadly speaking, is undersupplied with homes, so this need not lead to a price crash. But mixed with high rates and a slow economy, house price deflation at the end of this year cannot be ruled out.
Normaler doesn’t mean normal
Both these things are true:
The US economy is a lot more normal now than it was a year ago
The US economy is extremely weird
We’ve made the first point around here a fair bit. The personal savings rate is right back to its pre-pandemic average. The goods-to-services balance is close behind. Covid-19 restrictions are being rolled back. Today’s growthflationary environment, though painful, is hardly unprecedented.
Yet weirdness, not normality, remains the dominant economic theme. US housing (see above) are just one example. Look at this startling FT piece from the weekend:
From industrial metals to energy to agriculture, the rush for raw materials and food staples has been reflected in futures markets, where a large number of commodities have flipped into backwardation — a pricing structure that signals scarcity.
Problems are particularly acute in metals, where spot prices of several contracts on the London Metal Exchange are trading higher than those for later delivery, as traders pay large premiums to secure immediate supply.
“This is the most extreme inventory environment,” said Nicholas Snowdon, analyst at Goldman Sachs. “It’s a completely unprecedented episode. There is no supply response.”
This is not entirely a Covid story. A back-to-back drought and frost in Brazil last year is behind coffee inventories dropping to a 22-year low. Russia-Ukraine tensions loom over energy and grain markets.
It is mostly a Covid story, though. Lockdowns in China are hitting smelting capacity for metals such as aluminium. Oil production is trickling back online from its pandemic depths, but too slowly. Even if the US economy was totally normal, it would be operating in a global economy gone wild.
In America, still a developed-world outlier for Covid deaths and hospitalisations, pandemic restrictions have eased somewhat but are very much in place, according to Oxford’s index of government restrictions (via Our World in Data):
There are early signs of labour shortages levelling out, but a diminished employment-to-population ratio has some analysts asking whether the US labour force will remain permanently shrunk:
Shipping costs are following a similar flat-but-high trend, as FT Alphaville’s Claire Jones noted last week:
Unhedged has seen all the same supply-chain projections you have. Smarter people than us think that logistics will smooth out in the second half of 2022. Maybe so. But Clifton Hill, global macro portfolio manager at quant firm Acadian, reminded us that there is a viral asterisk on every forecast:
It’s an unbelievable time of historic [forecast] misses in everything from payrolls to inflation …
The forecast last year said [supply chains] were supposed to ease at the end of 2021, and that got moved to 2022 . . . These variants [are] why it’s so hard with forecasting. I remember Delta spread through Vietnam and Asia, and it caused a lot of supply constraints with things like Nike shoes. [Especially] in China, with their zero-tolerance policy, it becomes quite challenging if there is any type of outbreak.
All told, this is not a grisly picture, but it is once again a case for epistemic modesty. When things get weird, get humble. (Ethan Wu)
One good read
The SEC has big plans to regulate private markets, including a big announced last week to force detailed disclosure on hedge funds and private equity. It’s a rare example of an American regulator trying to get ahead of the next crisis, writes the FT’s Rana Foroohar.