The Fed tightened (again) and long-term interest rates fell (again) in a disconnection between the Fed and the bond market as great as any in memory.
Since spring, the Fed has tightened .75 percent, and bond yields have fallen .90 percent. By all traditional measures, such a counter-move is a bond-market forecast of a too-tight Fed, and a recession soon to follow. None seems near, though economic data do not support the Fed’s insistence that all is well with the economy.
If the Fed is nevertheless intent on raising its rate (its August meeting minutes: “Significant cumulative policy tightening likely…”), what would motivate a bond rally? Two answers are floating around: first, oil prices are hurting the economy, stocks are swooning (again) and inflation has receded. All true, but just another version of the pre-recession concept. Second theory: bond yields are falling because China and Japan are buying bonds in order to keep their currencies cheap, and they don’t care that bond yields are below fair value. Could be, but I don’t think they have enough money to move the global swap/derivative curve along with the cash bond.
I have no idea when, or which, but either the Fed is going to fold, entering an extended pause, or long-term rates are going to jump, a lot.
I promised last week to speak to the threat of a housing “bubble.” It is hard to find a financial publication without an article pointing to the large gains in housing prices prevailing in most markets in the last five years, and suggesting peril. Most of these arguments are on the hysterical side, perhaps driven by embarrassment at the lousy returns available from financial market investments. If your own products are doing poorly, criticize your competitors’.
Beggar-thy-neighbor aside, there is one aspect of analysis missing in all of the “Bubble!” cries: a discussion of the relative scarcity and price of land. All of the bubbleologists refer to “home prices” or “housing” as though a home is an integral object. It is not: a house is a set of physical improvements that depreciates every day by physical wear-and-tear and architectural obsolescence, falling in financial value, and certain to require removal and replacement someday. These improvements sit on land that is largely immutable, though its economic surroundings and uses change; land which gains value unsteadily over time. Land appreciates; improvements depreciate. The two together are “housing.”
The population of the United States has doubled in the last 50 years, and is now growing by 2.5 million people each year. Our land inventory is the same as it was, and will be. There is no new San Francisco Bay lying undiscovered somewhere in the Midwest; and as each hurricane makes landfall, it is painfully clear that there is no undeveloped reserve of coastline. We can develop increasingly remote or undesirable tracts, but our most attractive land is rising disproportionately in value.
Redevelopment is the stark evidence of good land as the durable element of increasing price, the reservoir of value from all aspects of “location.” Every metro area has a rolling debate about the allowable extent of “pop-top” and “scrape-off.”
That “housing” prices have departed per capita income, rental equivalence, construction cost and inflation seems perfectly normal and sensible to me. Given land scarcity versus existing population, plus a rising increment of discounted future value due to a certain increase in scarcity in the future, “housing” prices should be rising faster than comparison measures. Visit www.ofheo.gov, and study its micro-regional value history tables (the best available anywhere); in each region, compare the relative land-plenty or land-scarcity to its historical appreciation, and then join me in chanting, “Well… DU-UH!”
The double-digit housing gains of the last five years will soon slow with some grace and some pain, but not in the form of a blown bubble.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at firstname.lastname@example.org.
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