Fed Update: What Will 2007 Bring?
A: It's been a little while since I talked about the economy, inflation and monetary policy here on UrbanDigs. For a little while I was starting to think the fed actually got it perfectly right, slowing down the economy enough to ease inflation pressures, but not enough to cause an outright recession. Couple that with a correction in oil prices and the 4 month stock market rally is explained. But with today's PPI # and housing permits released, reality is starting to settle in. We are NOT out of the inflation woods yet!
A little over a year ago I wrote a post here on UrbanDigs about a fundamental shift of investing from housing to stocks. It was before I sold my apartment and was still struggling to make do with my enormous living costs. As much as I would have liked to just flip a switch and cash out my housing profit to put into stocks, things just don't work that way!
In the post titled, 'Will Growth Shift From Housing To Stocks', that I wrote back in November of 2005, I made a few statements as to why I thought the stock market was ripe for big gains in the coming year or two. If only I had the cash to follow my own advice!
I quickly learned the illiquid nature of housing as I listed my apartment for sale in January, took 5 months to find a buyer, and closed in early July with an all cash deal expedited by no financing. However, in that time the stock market already started to run and I stayed on the sidelines. A poor decision.
But you must move on! Buying into the stock market right now seems a bit risky to me after the 6-8% gains that were enjoyed in the past 6 months or so. As a contrarian investor, I like to sell high and buy low, even if that means holding onto no gains for a while if I don't time the investment perfectly. Who does. Looking forward, I am perfectly fine with my money getting 5.05% in a no-risk online savings account as I await future economic data to come in.
Today's economic data is a dose of reality! Inflation is not dead yet as the stock markets would have you believe with its unsustainable rally of recent months. According to CNN Money:
The Labor Department's Producer Price Index jumped a larger-than-expected 2 percent in November. The measure of prices paid by businesses posted their biggest gain since 1974. Core PPI , which strips out volatile food and gasoline prices , rose 1.3 percent, spurring inflation worriesA similar article in Yahoo Finance takes this data a bit deeper:
The Producer Price Index, which measures inflation pressures before they reach the consumer, was up 2 percent last month, the biggest advance since a similar increase in November 1974, the Labor Department reported Tuesday.You see, the PPI # tells us about inflation at the production level, which if present, will eventually trickle down to the consumer via higher prices for goods. So, this is sort of a forward looking # which should be interpreted as a warning sign for the months to come. The Yahoo Finance article continues:Economists had been expecting a rebound in wholesale prices following two months of big declines. However, the 2 percent jump was four times bigger than the 0.5 percent increase they had forecast. Even excluding volatile energy and food prices, core inflation posted a 1.3 percent advance, the biggest jump in 26 years.
The 2 percent rise in wholesale inflation followed four straight months of benign readings including outright big declines of 1.3 percent in September and 1.6 percent in October.So, we must be vigilint about this stuff. Its a lot to digest, I know, but if inflation peaks its ugly head again, then the fed will be forced into raising interest rates further in 2007 (not cutting), which would lead to a continuation of the housing correction going into 2008 or further.In those months, energy prices were falling sharply, a situation that reversed in November.
Food costs showed a small 0.1 percent rise last month after a big 0.8 percent decline in October as increases in the price of dairy products, eggs and soft drinks offset declines in vegetable and fruit prices.
The thing about housing is its illiquid nature. Once housing turns from a booming market to a slowing one, it doesn't just get one peice of good news and turn back around to good times. It takes time to work through inventory buildups. It takes time to get back to a interest rate environment where 30YR mortgages are below 5%. It takes time to get the all important 'time on market' indicator back down to where it was a few years ago. These things TAKE TIME to work out!
The housing boom lasted a good 4 years or so if you start the boom after 9/11 and end the boom in mid 2005. Others will argue that the housing boom started way earlier with 9/11 just a short term blip in the run. I'll buy that as I was priced out of the housing market for years before 9/11 showed a few opportunities. So whether the boom was 4 years or 7 years, it really doesn't matter. The point is it lasted a good period of time. With the peak in housing occurring around mid 2005 (in hindsight), we are now about 18 months into a slowdown. What if the slowdown lasts 4 years? What if it lasts 7 years? Only time will tell and we must follow all the signs that will forecast a brighter future for housing down the road. These include lower interest rates making housing more affordable, less time on market indicating strength in the buyer pool, lower inventory keeping supply lower than demand, and a strong economy generating enough income for people to buy new homes.
I'll leave it to you to decide when to re-enter. As for monetary policy, here is what I think the fed will do.
NEXT MEETING: No Change. Inflation remains a concern.
WHAT WILL MAKE THE FED CUT IN MID 2007: Easing inflation #'s and a continued softening of the housing market will make the fed cut rates in 2007.
WHAT WILL MAKE THE FED RAISE IN MID 2007: More economic data like today's PPI #. If energy continues to rise above the $70/Barrel mark again. A strengthening housing market and a continued rally in equities will tell the fed the economy is very strong and might need to be slowed.
I think 2007 will be flat to down for housing as we iron out the fundamental bumps of inventory and weak speculators. Those who bought between 2003-2005 with short term interest only loans will have some problems and might be forced to sell. Stocks will have another up year, but not as good as 2006. Inflation's true face will either show or go away in 2007. I will certainly be keeping my eyes on inflation and energy prices as I think these 2 guys will be the best indicators of future monetary policy, equity direction, and housing's level of correction.
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