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Fed Targets Long Rates and Real Estate…and China

Federal Reserve Chairman Alan Greenspan told Congress today, “Our baseline outlook for the U.S. economy is one of sustained growth and contained inflation pressures… In our view, realizing this outcome will require the Federal Reserve to continue to remove monetary accommodation.” Mr. Greenspan is saying inflation pressures are well contained, but the Fed still needs to keep raising interest rates. So far in this cycle of rate increases, the Fed has been impotent in their efforts to raise long-term interest rates. The Federal Reserve has raised the target for the overnight bank lending rate from 1% to 3.25% since June last year, but during the same period the yield on the 10-year Treasury note has dropped 40 basis points. With reference to the “interest rate conundrum,” Mr. Greenspan commented, “Such a pattern is clearly without precedent in our recent experience.”

Increases to the Fed Funds rate have not impacted the long end of the Treasury curve because the Asian countries keep buying our ten and thirty-year debt paper, thereby holding interest rates low. By purchasing an inordinate amount of long-term treasuries, China, Japan, and all the other exporting countries actually end up setting our long-term interest rates. By purchasing our debt, interest rates remain low and the American consumer keeps on consuming more and more inexpensive goods, especially from China.

While low interest rates fuel further consumption, Mr. Greenspan is concerned the low long-term interest rates are creating speculative “froth” in some real estate markets around the country. Americans are still extracting home equity via refinancing, which is also a contributing factor for more consumption funded by debt. Today the Mortgage Bankers Association said their applications index was higher by 1.2% with the purchase applications down by 0.1%, but the re-fi index was higher by 2.5%. Over the past week rates on thirty-year fixed mortgages moved from 5.62% to 5.72% with the average one-year ARMs moving from 4.56% to 4.63%. If you have any refinancing needs, better get it done before the Fed pushes long rates higher with continued increases in the cost of money.

A Brief Pause…

I’m finding it most difficult to write today as I spent most of the morning listening to Mr. Greenspan in front of Congress while monitoring my trading positions. Through most of the morning the markets were fairly quiet, but since the Fed Chairman finished his testimony, a great deal of volatility has entered the markets. The dollar was strong early in the session reaching a high of 90 on the U.S. dollar index (due to continued rate hikes), but has since fallen to 89.20, down a half-point from yesterday’s close. The euro, Swiss franc and pound made noteworthy turns to the positive in today’s late trading.

Similarly, stocks have been all over the board today. At the onset, stocks were under pressure with the idea that rates will move higher, plus a slew of negative earnings reports came from Wall Street. Intel gave a disappointing forecast and Yahoo missed their quarterly sales number. General Motors reported a surprise for the second quarter with a loss of $286 million. Eastman Kodak reported a third consecutive quarterly loss and said they will probably lay-off another 10,000 workers, bringing total job cuts to 25,000. J.P. Morgan posted its lowest quarterly profit in a year because of costs for legal settlements and a 50% decline in trading revenue. With about an hour to go, stocks are back to near breakeven for the day, so I’ll come back to check the closing numbers…………the last hour of trading moved prices higher with the Dow Industrials adding 42 points to 10,689 and the NASDAQ Composite moved 15 points higher to close at 2,188. The big mover for the day was the Dow Jones Transportation Average with a gain of 3.6% or 132 points to close at 3,769. Separate reports had China’s economy growing faster than expected at a 9.5% growth rate with an increased appetite for coal and crude oil. The Transportation Average suggests the global economy isn’t quite ready to put on the breaks just yet, as goods must have transportation to the marketplace.

Back to the Real Estate Conundrum

Yesterday the Commerce Department said home builders broke ground on 2.004 million housing units at an annual rate in June. The number was flat versus May, as it is presumed that builders are catching-up with the backlog of homes currently under construction. They are building just as fast as they possibly can, and the NAR suggests prices will still be moving higher. From a Bloomberg article yesterday:

“The National Association of Realtors, the U.S. industry’s largest trade group, said on July 13^th that home prices will probably rise 9.4% this year, the fastest pace in a quarter century. The group said it expects the median price to rise to $202,600 this year from $185,200 in 2004. ‘The most notable problem in the housing market is the shortage of homes available for sale, as well as some shortages of building materials,’ said David Lereah, the chief economist at the National Association of Realtors.’”

When I read the comments from Bloomberg yesterday, I thought it quite strange that the NAR sites the biggest problem for real estate is the lack of inventory for sale. I believe that is all about to change very soon if Mr. Greenspan has his way with long-term interest rates. The lack of inventory argument from the NAR also brought to mind an article I remembered reading over the weekend. The article, “Beginning of the End of the Housing Bubble” by Russ Winter appeared on wallstreetexaminer.com last Friday. You can see his take on the real estate inventory situation in contrast to what the NAR had to say.

In one key speculative casino, Las Vegas, MLS listings which were 14,380 in April, and 17,005 in late May, hit 18,124 in early July. Price reductions have been running about 5% per week in that market, and that's right at a time when a surge of new and very expensive high rise units is coming on stream.

We see a new high in both total listings and price reductions downtown, swamping new pending (16 a week over last 4, with 3.5 a week falling out of escrow). In fact, in the last four weeks this market has seen 104 price reductions on 408 listings. Average price sold hits the lowest of the year. Sales after subtracting falls from escrow were 50, versus 408 listed, that's 8.16 months inventory.

This is confirmed out in San Diego County, where Sandicor reports latest June activity, where listings continue to surge, as sales huff and puff to keep up. The listing to sales ratio in the first half of 2004 was 1.76. This year it was 2.12. Turn out the lights, the party's over.

In just a two week period in Arizona, single family listings rose by nearly 1,000 units.
6-28-05: 10,200           7-7-05: 10,746            7-13-05: 11,182

Just for fun and to demonstrate the quick bang turn of events, how about Jupiter, Florida? Realtor.com shows listings of two-bedroom, two-bath units in the $100,000 to $500,000 price range, going from 150 units on June 15, to 199 today.

In California, the Sacramento Bee on July 14 reported that:

The inventory of resale homes jumped 40 percent in the past two months and suggests price appreciation will cool this summer. Sellers are being forced to compete more aggressively and buyers - especially those seeking homes priced above $500,000 - are enjoying far more choices in many neighborhoods. The 6,246 resale homes in Sacramento, Placer, El Dorado and Yolo counties combined at the end of June represented an 18 percent gain from May and a 52 percent increase over June 2004, according to TrendGraphix, a data firm affiliated with Lyon Real Estate of Sacramento.

This quote from the article says it all, speculators are fleeing like rats:

One of the nearby "For Sale" signs is for an investor-owned rental home listed by Sergio Arreguin, a Keller Williams Realty agent. Arreguin said about one-quarter of the homes for sale in the neighborhood are owned by investors, including some who are his clients. "They (investors selling homes there) were simply at a point where they felt the market was creeping up to its peak, per se, and they wanted to liquidate as much as they could and do it rather quickly,"

From a Reuter’s article on Monday titled, “Weak British house price data weighs on sterling,” the article goes on to say, “British house prices rose at their weakest annual rate in ten years in July as owners desperate to move dropped their asking prices, a survey showed. Asking prices for British properties fell by 1.0% in July from June and were up by just 0.2% year-on-year, as homes for sale piled up in estate agents’ books, according to the Rightmove report…The house data does not say anything new as we all know that the housing market is slowing,” said Chris Gothard, currency analyst at Brown Brothers Harriman.” Some analysts suggest British property price trends precede trends in the U.S. by approximately six months.

In front of Congress Mr. Greenspan said today, “We certainly cannot rule out declines in home prices, especially in some local markets. If declines were to occur, they likely would be accompanied by some economic stress, though the macroeconomic implications need not be substantial.” The macroeconomic implications “need not be substantial” in my mind registers as a “hope” that overvalued real estate doesn’t collapse in a waterfall decline if China dumps our Treasury paper forcing long-term interest rates to shoot higher with no prior warning. Mr. Greenspan has been in his little conundrum with interest rates because he can’t tell China to stop buying long-term Treasuries. Similarly, Treasury Secretary Snow tells China the time to revalue their currency is “NOW”, but he can’t tell them what to do either. If China decides to revalue their currency tomorrow and simultaneously decide not to buy any more U.S. Treasury debt, it will be Mr. Snow that will have to figure out a new way to finance our federal deficits, or put another way, find another country that will lend us the money that has been coming from China. The deeper we go into debt with our foreign creditors, the less we have control over our own destiny…the debtor is slave to the lender. When will they get a clue?

Have a Great Evening!

Mike Hartman

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