The question of the day is “What are Americans buying?” The answer was provided by Fed governor Richard Fisher in response to a question on housing:
Q: What are the positives that are helping the economy weather the housing downturn?
A: Americans will buy anything that looks good, feels good, smells good and tastes good. We’re great consumers. And consumption is over 70% of GDP.
Gee. What a great nation we could be if we could only manage to consume 200% of GDP.
Unlike Fisher I keep wondering how people are buying stuff. Mark Kiesel at Pimco who is Still Renting seems to feel the same way.
Over the past several years, consumers leveraged rising housing prices and easy credit availability using their home as an ATM. Mortgage equity withdrawal (MEW) soared, allowing consumer spending to grow faster than income growth over the past several years. This process was facilitated by rising home prices and loose lending standards. As long as housing prices were rising, lenders were willing to lend, and consumers were willing to spend, as rising housing prices gave them the confidence to draw down on savings.
Today, mortgage equity withdrawal appears tapped. Consumers have been accessing their homes as bank accounts, but housing prices are now falling in many areas, and credit is becoming more difficult to obtain. The slowdown in MEW has been remarkably swift. Over the past year, consumers tapped over $400 billion less equity out of their homes than the previous year. And, in looking at the four-quarter moving average of MEW divided by nominal GDP, the change in MEW as a percent of nominal GDP is now –1.8% Slower housing price appreciation is causing mortgage equity withdrawal to fall sharply, and is set to detract from U.S. economic growth.
Housing Is Today’s Leading Indicator
Housing is today’s leading economic indicator. To quote our forecast from one year ago in For Sale, “with a softening housing market, we should expect tighter lending standards, a moderation in the willingness to take risk, a slowdown in the pace of asset price appreciation, less liquid markets, and rising volatility in financial markets.” On the economic front, I believe declining housing prices and tighter credit are set to unleash a sharp downturn in housing turnover and job creation. As housing prices fall, corporate profits are expected to be at risk as consumers pull back their spending.
Housing is a momentum market. Turnover rises when real housing prices, as defined as housing price appreciation (HPA) minus mortgage rates, are rising. Turnover slows when real housing prices are falling (Chart 9). Today, the growth in real housing prices is falling. We believe real housing prices will turn further negative in 2007, causing new and existing home sales to decline towards 5 million units per year, down from a peak of over 7.5 million units per year in 2005.
Housing starts and permits tend to be a good leading indicator of job growth. Through February 2007, housing starts are down –28% year-over-year. This type of decline in housing starts typically leads to a sharp slowdown in job growth, within roughly one year. As a result, I believe that job creation is set to slow, possibly materially. The U.S. economy created approximately 200,000 new construction jobs last year. It would not surprise me if we lost 400,000 construction jobs this year, as homebuilders complete their existing projects and then lay off workers. As corporate profit growth deteriorates with a slowdown in housing, business investment and consumer spending, layoff announcements across all sectors of the labor market will likely pick-up.
Housing is today’s leading indicator of economic growth and risk appetite. An extended downturn in housing will likely lead to slower job creation, softer corporate profit growth, tighter lending standards and weaker consumer and business confidence. The Fed should lower the Fed Funds rate as soon as we have confirmation that the employment situation is deteriorating. By that time, credit spreads will have already anticipated the fact that risk appetite is set to turn for the worse.
For renters and potential homebuyers, my advice is to still rent. The housing market has turned for the worse but the unwinding of this bubble will take more time. Unfortunately, this is not good news for the U.S. economy, job creation or corporate profits. Nevertheless, investors who are patient and adopt a conservative investment strategy should prosper over the next few years.
I happen to agree with Mark Kiesel about housing, jobs, weaker consumer spending, and credit spreads. I also think emerging markets are likely to get hit hard if the US goes into a recession. But right now the markets seem to have a mind of their own especially in regards to yields.
Things with the same yield
- 30 year Treasuries
- 2-year Fannie Mae Benchmark Notes
- 2-year Freddie Mac reference Notes
- World Bank 2-year notes
- Mexican Global 2-year notes
- Brazilian 2-year notes
- Colombian Global 2-year notes
- Chilean 2-year notes
- Peruvian 2-year notes
- 2-year Citigroup notes
I find the above comparison quite amazing and so did Bennet. Nonetheless, that’s how correlated risk is right now. The “Feels Good” society has now gone global.
Mike Shedlock / Mish/