Age of Wisdom, Age of Foolishness (10): “The American Jury Is Out, But the European Jury Has Voted”
The American jury was still out in the first real trading week of the New Year. The case for the Defendant rested upon proof that the US economy was strengthening enough to justify the “Taper” decision taken by the Federal Reserve on December 18th 2013.
Counsel for the Defence called the HOPE NOW Alliance “Acronym” to the stand first. Under leading examination by the Defence, HOPE NOW opined that 50,000 home loan modifications had been undertaken in October 2013; and that this programme was substantially contributing to the economic recovery[i]. The Plaintiff declined to cross-examine. The Office of the Comptroller of Currency (OCC) was then called to the stand as a witness for the Defence. The evidence provided by the OCC showed that delinquencies improved in Q3/2013[ii]. There were no questions from the Counsel for the Plaintiff. Next the Lender Processing Service (LPS) was called upon, by the Defence, to testify that its House Price Index increased by 0.1% in October; which represented an 8.8% year-on-year improvement[iii]. The Counsel for the Plaintiff immediately objected that all this evidence was too historic, as the trial was in relation to where the economy was in Q1/2014 and where it was going henceforth.
The Plaintiff called Case-Shiller S&P Dow Jones Indices, who testified that in fact the housing market was losing momentum in October[iv]. Expert witness David M. Blitzer, Chairman of the Index Committee at S&P Dow Jones Indices testified under oath that,
“monthly numbers show we are living on borrowed time and the boom is fading”.
RedFin was then called upon, by the Defence, to opine that the time spent on the market by homes shortened from October to November[v]. The Plaintiff countered that it was now January 2014 not November 2013. Further evidence was provided from Pending Home Sales and CoreLogic[vi] who showed sales improved 0.2% (monthly) and 11.8% (year-on-year) in November respectively.
CoreLogic testified that the “Shadow Inventory” was at its lowest level since 2008. Once again, the Plaintiff countered that this evidence was too historic.
Freddie Mac was then called to the stand by the Defence; and testified that its serious delinquency rate was at its lowest level since 2009[vii]. Counsel for the Plaintiff then became hostile and demanded an explanation of why Freddie Mac’s book of business was shrinking whilst that of Fannie Mae was expanding in November[viii]. Freddie was reminded that it was under oath and that perjury is a serious offence. Fannie Mae’s book had expanded in both October and November, whilst that of Freddie Mac had declined significantly. Plaintiff’s Counsel speculated that in fact the housing market was deteriorating and that Freddie Mac was rushing for the exit; whilst Fannie Mae, under pressure from its Government Custodian, was being forced to support the market whilst Freddie hit the bid.
Defence Counsel objected on the grounds of pure speculation; and then countered with alacrity by calling CoreLogic; who testified that the co called “historic” evidence came from “low-end” house prices, which were rallying the most and led the broader market by a period of six months[ix]. The objection was sustained.
Fannie Mae was then recalled by the Defence and provided detailed evidence with exhibits for the Jury[x].
Exhibit 1 showed that consumer consensus believes that house prices will rise over the next twelve months.
Exhibit 2 showed that house prices are expected to improve by 3.2% over the next twelve months.
Exhibit 3 showed that consumers are better buyers than sellers of houses over the next twelve months.
Exhibit 4 showed that consumer consensus is for rising rents over the next twelve months.
Exhibit 5 showed that rents are expected to rise by more than house prices over the next twelve months. The Plaintiff’s Counsel objected that this shows that speculative investors have created a “bubble” which is not sustainable. Defence Counsel argued that the rise in rents will cause consumers to buy rather than to rent, so that the market is fundamentally supported.
Exhibit 6 shows that, although there is no strong consensus, on the direction of the underlying economy, there has been an increase in positive sentiment and a decrease in negative sentiment since Q4 began. The Plaintiffs declined further questions.
The FOMC was then called to the stand by both sides.
Plaintiff’s Counsel called upon its star witness Ben Bernanke. Mindful of being under oath, Bernanke testified that, whilst the economy showed clear signs of improvement, it was dangerous to believe in forecasts[xi]. The Defence declined to cross-examine Bernanke. The Defence then called upon Charles Plosser, who testified that the economic recovery was robust enough to require greater “Tapering”. This time the Plaintiff’s Counsel declined to cross-examine. Jeffrey Lacker was then called to the stand, but neither side could extract much value from his equivocal data-dependant testimony. Little value could also be extracted from the last FOMC minutes, which showed vigorous debate resulting in a compromise decision to “Taper” by $ 10 billion a month[xii].
Defence Counsel then concentrated on undermining the Plaintiff’s argument that the evidence provided so far was too “historic”.
Defence called upon RealtyTrac to testify two important facts[xiii].
Firstly, there were fewer homes classified as “Deeply Underwater” as of December 2013.
Secondly, 31% of homes classified as being in negative equity actually had positive equity in December because of the recovery in home prices[xiv]. The term “Equity Rich” was applied to this growing universe of homes that had been resurrected from negative equity. Plaintiff’s Counsel argued that these “Equity Rich” are signals of a bubble rather than an economic recovery; so that the “Taper” is supposed to address this bubble rather than as a consequence of economic strength.
The Plaintiff then called Trulia to the stand, who testified that the house price recovery was actually showing signs of slowing in December[xv]. The Defence declined to cross-examine. The Jury was then directed to adjourn to make its deliberations. The markets await the announcement.
Key individuals, in addition to the data, are also on trial in relation to the economy and the housing market. The jury is still out on Janet Yellen. Even though she was confirmed, as Chairman of the Fed by the Senate, the voting margin was lower than that for Bernanke. The jury is also still out on Mel Watt, the new head of the FHFA. His early decision to hold off on raising G-Fees is the source of the doubt. The consensus school of thought believes that this is code for a new Federal housing stimulus. Raising G-Fees would have made private sources of capital competitive with Federal sources; which would have allowed the shrinking of the Federal Footprint in housing. Clearly stalling the rise in G-Fees frustrates this shrinkage. Our analysis suggests that Watt is playing for time to see how the housing market evolves, now that the “Taper” is a material fact and the market has begun to raise its interest rate expectations. Rising interest rates are a headwind to mortgage borrowers. Mortgage lenders will also dump their inventories as rising interest rates threaten capital losses. In addition, rising capital adequacy charges from Basel III and Volcker II push lenders out of the business. The housing market is under threat from rising interest rates and capital costs. Watt has decided to hold back on adding another headwind to the housing market. His decision is rational, even if politically motivated. For Watt, the jury is still out on the housing market.
European Risk On
In this time of American uncertainty, it was interesting to see one jury voting with its feet. This was the jury of global central banks. Global central banks have begun to diversify their reserves away from the US Dollar again. This signals that they are comfortable with the assumption that the “Taper” is not a tightening; but rather a slower pace of easing. To underline this perception, the Gold Bugs also got to work again buying the precious metal in anticipation of flows out of the US Dollar. The campaign against Bitcoin also became more aggressive; which suggests that another leg of global central bank printing is underway. This easing charge seems as though it will be led by the ECB this year. Mario Draghi’s first press conference of the New Year signalled that he is focused on the threat of deflation in Europe. The markets were happy to support his focus, as the bond markets re-opened for Ireland and Portugal. The signal was confirmed by the outperformance of Peripheral assets. The jury is clearly no longer out on the Periphery; and speculators have voted with their feet in the first week of 2014. Behind the scenes also Secretary Lew’s first business trip of the year was to Europe; presumably to apply pressure for economic stimulus there to counter the perceived reduction in stimulus from the Fed. Japan was scheduled to provide the global liquidity in 2013, this year it will be the ECB.