Fed Update: Oil & Housing Data

Posted by urbandigs

Wed Jan 17th, 2007 08:36 AM

A: With a spectacular correction in oil prices (recall my 2007 predictions I published Jan. 2nd when oil was trading at $61/Barrel) and lack of doomsday data from housing over the past few weeks, there really hasn't been much to talk about on the monetary policy front. The fed will easily hold rates steady for the first half of the year, giving all the rate-cut arguments less chances of success. This week has some important data coming out so short term expectations on interest rates may drastically change.

Oil Plunges Below $51/Barrel

Warm weather, growing inventory, and a cancellation of an emergency OPEC meeting all contributed to the plunge of more than 16% of light sweet crude prices since the start of the year. As noted in the CNN article:

Oil prices plunged more than 3 percent back near $51 a barrel Tuesday after Saudi Arabia said OPEC production cuts were working well and that there was no need for an emergency meeting of the producer group. The Organization of the Petroleum Exporting Countries (OPEC) agreed to cut 1.2 million barrels per day (bpd) of output from Nov. 1 and then to cut another 500,000 bpd from Feb. 1.
This is good news for inflation fears as the correction should lead to lower operating costs for almost every corporation that is affected by higher energy prices, and put to rest worrys that product prices will be increased as a result (inflation).

In relationship to interest rates, lower energy prices will help keep the fed on the sidelines. With the hard and fast correction in oil over the past few weeks, I would expect contrarian traders to start buying with the very short term expectation of oil being oversold, and a small rally back to $55 or so where a new trading range will be formed.

Economic & Housing Data

This week brings us a few very important pieces of economic data that will ultimately affect short term expectations on future monetary policy. If the economy is heating up or housing reports show strength, expect NO rate cuts and possibly a hike before the year ends. On the flip side, if the economy is showing weakness, especially in housing, the fed might jump in quicker than previously thought to cut rates to prevent the economy from slipping into a recession.

For all those who dont understand why I talk about this stuff, its because it affects monetary policy; and its hard to argue that monetary policy is directly linked to real estate cycles. As affordability goes down due to rising borrowing costs, buyer demand softens and inventory rises ---> leading to a slowing real estate cycle and a correction in price appreciation. Simplicity applied to the real world. I like to look to the sources of such change, that is, what makes monetary policy become restrictive or stimulative.

On tap for this week includes:

TODAY - Core PPI Report
TODAY - PPI Report
TODAY - Crude Inventories
TODAY - Fed's Beige Book

JAN 18 - Building Permits
JAN 18 - Core CPI Report
JAN 18 - CPI Report
JAN 18 - Housing Starts
JAN 18 - Initial Jobless Claims

Lots of data to digest! I'll certainly be keeping an eye on the most recent evidence that the economy is staying strong or starting to show signs of weakness. We will also get good data on the inflation front, but its too early to see the results from the plunge in oil prices over the past 2 weeks. That should start to show up in economic data in 2-4 months or so.

NEXT FED MEETING JAN 30-31 - Expect NO CHANGE in rates. Inflation will still be a concern for fed members as changing their stance as tough against inflation will have negative affects. We need a hawkish fed, at least one that portrays that image, and thats exactly what they will do.

On a side note, Calculated Risk reports on Dr. Edward Leamer's (Director UCLA Anderson Forecast) prediction on whether or not the housing recession will infect the overall economy:
The models that rely on history suggest that the extreme problems in housing currently being corrected will almost surely infect the rest of the economy, but that history does not take into account two important facts:

• Manufacturing is not poised to contribute much to job loss.

• Real interest rates are very low and there is no evident credit crunch, now or on the horizon.

These facts make the problem in housing less severe than it would be otherwise, and help to confine the pathology to the directly affected real estate sectors: builders, real estate brokers and real estate bankers.

The models say "recession;" the mind says "no way." I’m going with the mind. This time the problems in housing will stay in housing. If you are a builder or a broker, it will feel like a deep depression. The rest of us will hardly notice.
So far, the economic data seems to back this up as stocks are clearly betting on a resilient US economy, declining inflation pressures, and strong corporate profits. As I noted in earlier posts, in my mind the biggest threat to housing's level of correction is weaker jobs reports that I think will come in later this year and tightening lending standards restricting purchasing power.