Dollar Wins & Housing Loses
Last week Ben Bernanke declared that the inflation battle was far from over and he suggested that interest rates could be rising.
Given that January wholesale prices collapsed 0.6% and inflation was at a moderate 0.2%, why the hawkishness? Yes, inflation exists but it is well within the normal range established by the Fed (<3% annualized).
Arguably the Fed has engineered us away from a looming train wreck. The combination of a falling economy and the crash of the housing market would have pushed the US into a hard recession. Instead, we have a fairly strong economy that is withstanding the housing blahs. At least for now.
Will this situation continue? Probably not. The economy will weaken over time and the housing burst will take a bigger bite.
But for now at least, the Fed has bought some time and wiggle room.
That wiggle room is important because the Fed was taking a major gamble: that a housing crash would not bring down the broader US economy.
Why would they be focused on sacrificing the housing market? Because they have to choose between the dollar and housing, and the dollar drives much more of the economy.
The common variable between housing and the dollar is interest rates. As you've noticed in the past few months, interest rates are rising in Europe and Japan. That matters because the US is now ~$800B in debt which it finances via treasury bills. (Yes, Tbills are sold to cover the budget deficit but the market for them is primarily to cover the trade deficits.) Those T bill sales must compete with Euro sales, and bankers focus on the rates. Interestingly, Tbill rates increased almost 0.45% as the market realized that the US might not lower interest rates (based on the stronger-than-expected economy) and that better tax revenue meant the Treasury wouldn't have to sell as much to cover the budget deficit shortfall.
What happens if the dollar does not stay competitive? The US gets an export advantage but since most of the deficit is oil, and oil will just get re-priced to handle the dollar weakness, much of the deficit won't change. A more important piece is that countries will no longer want to trade goods for the US dollar, not when equally liquid but stronger currencies are available. The news is already littered with countries starting to turn away from the dollar.
My point is that major external pressure is being exerted on the US by the international financial markets. The Fed is trying to keep the dollar attractive and interest rates are the only tool it possesses to achieve this.
My conclusion is that the Fed intends to keep the dollar strong via interest rates, but it is forced to do so wth deception. Why else would Bernanke refer to inflation worries and allude to possible hikes when every data point shows a mellowing of inflation? Especially when the rising interest rates kill the housing market. That was something Barney Frank wondered too.
Well, bad news: housing is going to get sacrificed. The Fed will not inject liquidity to save it. If anyhing, it wants to tighten. Already new rules have gone into affect. The market is obliging as well: several lenders have declared bankruptcy. Without easy money but in the face of rising mortgage payments, foreclosures will accelerate. No buyers means no sellers. It also means that, according to supply-demand rules, a lower demand with higher supply equals lower prices. Which hurts mainly investors and people who lose their houses, but it is deflationary in practice.
The tea leaves are showing no mercy for the housing markets. Watch out.
Given that January wholesale prices collapsed 0.6% and inflation was at a moderate 0.2%, why the hawkishness? Yes, inflation exists but it is well within the normal range established by the Fed (<3% annualized).
Arguably the Fed has engineered us away from a looming train wreck. The combination of a falling economy and the crash of the housing market would have pushed the US into a hard recession. Instead, we have a fairly strong economy that is withstanding the housing blahs. At least for now.
Will this situation continue? Probably not. The economy will weaken over time and the housing burst will take a bigger bite.
But for now at least, the Fed has bought some time and wiggle room.
That wiggle room is important because the Fed was taking a major gamble: that a housing crash would not bring down the broader US economy.
Why would they be focused on sacrificing the housing market? Because they have to choose between the dollar and housing, and the dollar drives much more of the economy.
The common variable between housing and the dollar is interest rates. As you've noticed in the past few months, interest rates are rising in Europe and Japan. That matters because the US is now ~$800B in debt which it finances via treasury bills. (Yes, Tbills are sold to cover the budget deficit but the market for them is primarily to cover the trade deficits.) Those T bill sales must compete with Euro sales, and bankers focus on the rates. Interestingly, Tbill rates increased almost 0.45% as the market realized that the US might not lower interest rates (based on the stronger-than-expected economy) and that better tax revenue meant the Treasury wouldn't have to sell as much to cover the budget deficit shortfall.
What happens if the dollar does not stay competitive? The US gets an export advantage but since most of the deficit is oil, and oil will just get re-priced to handle the dollar weakness, much of the deficit won't change. A more important piece is that countries will no longer want to trade goods for the US dollar, not when equally liquid but stronger currencies are available. The news is already littered with countries starting to turn away from the dollar.
My point is that major external pressure is being exerted on the US by the international financial markets. The Fed is trying to keep the dollar attractive and interest rates are the only tool it possesses to achieve this.
My conclusion is that the Fed intends to keep the dollar strong via interest rates, but it is forced to do so wth deception. Why else would Bernanke refer to inflation worries and allude to possible hikes when every data point shows a mellowing of inflation? Especially when the rising interest rates kill the housing market. That was something Barney Frank wondered too.
Well, bad news: housing is going to get sacrificed. The Fed will not inject liquidity to save it. If anyhing, it wants to tighten. Already new rules have gone into affect. The market is obliging as well: several lenders have declared bankruptcy. Without easy money but in the face of rising mortgage payments, foreclosures will accelerate. No buyers means no sellers. It also means that, according to supply-demand rules, a lower demand with higher supply equals lower prices. Which hurts mainly investors and people who lose their houses, but it is deflationary in practice.
The tea leaves are showing no mercy for the housing markets. Watch out.
posted by Andrew at
2:56 PM
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