Weekly inflation outlook: an antacid for my headaches

This week, we will again have several opportunities to reconsider the conventional wisdom that when mortgage rates go up, house prices must go down. Last week the median house prices in the report would have declined about -1.5% month over month (mom) on a seasonally adjusted basis (I had to look at the seasonal as they don’t report seasonally adjusted figure).

Prices have fallen over the past two months, although some of that is seasonally normal. Tuesday’s data will be higher quality data from July (S&P CoreLogic Case-Shiller data) which should show a small gain of 0.2% m/m. House prices have definitely come down and are down in some ridings.

But it’s still a little hard to tell how much of this is simply exaggerated late summer seasonality, how much struggling sellers are bidding, and how much a drop in the nominal real equilibrium price. Because we also see stories like this from Redfin last week:

The “new oddity” in this case is that house prices are falling in real terms, but not in nominal terms. It’s actually not weird at all. According to the story, confirmed by many other reports, “there are very few new offers on the market”, which means that even though there are fewer buyers due to rising mortgage rates, there are also fewer vendors.

There is literally no magic that higher mortgage rates lead to lower prices, at least in the short term. Every buyer, of course, has a “loss” because they are paying a higher mortgage rate than a few months ago. But every seller is sitting on an equal gain if they have a fixed rate mortgage, which is now better than the market. A homebuyer, after all, buys a property and “issues a bond” (accepting a mortgage) to pay for it. The seller of the house disposes of the asset and redeems the “bond” he had previously issued, at par. Except now that interest rates have gone up, this “bond” is trading at a discount, so buying it back at par represents a loss for the seller of the home (and, more importantly, a non-taxable loss since the IRS does not recognize it in the form of a bond transaction).

This is different from some other countries where adjustable rate mortgages are much more common than they are here. Clearly, a home seller who has an adjustable rate mortgage does not face the loss of their below market interest rate and is likely more likely to sell.

The larger issue, however, that I have already discussed, is thinking that a house price correction should occur in nominal space when, in fact, it should occur in real space. . Why don’t the owners sell? My God, I have no idea…maybe because they have a real asset backed by a nominal loan in a booming economy? In this environment, the only sellers who bid aggressively are those forced to do so by circumstances. So the indices may go down if there is a selection bias to favor desperate sellers more than desperate buyers, but I don’t think they will go down much.

Take a step back…

Global central banks are reining in interest rates like they haven’t in decades. I continue to repeat my mea culpa which I absolutely did not expect.

It is also, I repeat, the wrong medicine. The money supply is 40% higher than it was before the crisis and prices are 15% higher. This gap needs to close and if the Fed does not aggressively reduce the money supply, prices will continue to rise until this gap equals the total growth of the real economy over this period.

I keep trying to find ways to convince people that the Fed’s aggressiveness should definitely have an impact on liquid asset prices, but it’s unclear if that should have much of an impact on the inflation. Here is my latest:

  • It took years of zero rates—if low interest rates cause inflation—to get inflation. If rates are the answer, then shouldn’t it take years to get disinflation?
  • On the other hand, it only took a few months of explosive monetary growth to cause inflation. If money is what matters, we could change the price level quickly by changing the money supply.

I’m not saying the Fed shouldn’t raise rates or, rather, just allow interest rates to return to free market levels rather than keep them artificially low. Of course they should. What I’m saying is that this drug addresses the asset price problem, not the consumer price problem. If you have a headache and you take an antacid, it still has an effect. It just doesn’t solve your headache.

Disclosure: My company and/or the funds and accounts we manage have positions in inflation-linked bonds and various commodity and financial futures and ETFs, which may be mentioned in this column from time to time.

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