Tomorrow afternoon all eyes will be on the Federal Reserve, which is currently holding one of its every-six-weeks get togethers. I and probably the rest of the world expect no change in the Fed Funds rate. It is currently near zero, so there is no room for further cuts, and it is extremely premature for them to raise rates again.
The real interest will be in deciphering the policy statement. I would expect a more upbeat tone about the pace of economic growth and continued confidence that they have inflation under control. There is about a mile of economic slack in the system, and while there are some indications that it is starting to be reeled in (for example, capacity utilization up two months in a row) we are a long, long way from any tension on the line.
As the graph below (from http://www.calculatedriskblog.com/) shows, historically the Fed has waited until well after unemployment peaks to start tightening up interest rates. After the 1991 recession they waited 18 months after unemployment peaked to start raising rates, and after the 2001 recession they waited a full year. Keep in mind, in both cases unemployment peaked well after the recession was over.
Currently unemployment is still rising, and is already at much higher levels than in either of the last two peaks. The earliest the Fed is likely to increase rates is probably the end of 2010.
Tomorrow afternoon, we will publish a paragraph-by-paragraph comparison and interpretation of the new Fed statement versus the pervious statement.
One of the key things to look for will be if they are going to end their quantitative easing programs soon. They have just about filled up their previously announced quota of buying Treasuries, so they may announce that they are done there. Through mid-September, they had bought $285 billion of the $300 billion of longer-term treasuries they planned to buy through the end of October.
On the Fannie Mae (FNM)- and Freddie Mac (FRE)-backed securities front they have already bought $840 billion of the $1.25 Trillion planned by the end of the year. That far exceeds the total amount of GSE-backed paper issued this year (about $440 billion), and when completed will represent almost 25% of all outstanding paper. The buying of MBS paper is a substantial deviation from classic central banking practice.
This has been a huge prop to the mortgage (and by extension, the housing) market. But what happens when the program is completed? The timing will roughly coincide with the expiration of the first-time buyer tax credit (11/30).
So far this year we have seen some stabilization and even signs of recovery in the housing market. For example, existing home sales were 15.2% higher in July than they were in March. The August data on used homes is due out on Thursday morning.
Even on the pricing front there are some signs that things are turning around. This morning the FHFA housing index, which tracks the prices of repeat sales of houses backed by the GSEs, showed a month-to-month gain of 0.3%. While that was less than the 0.5% consensus expectation, it was still up. On the other hand, prices were still down 4.2% year over year.
The FHFA index has a bigger weight on lower-priced homes than does the Case Schiller index, which is due out early next week, and which through June had shown a 15.4% year-over-year decline. The CS index is generally considered the gold standard of house price indexes.
There is a very real risk that the housing could slip back after these artificial supports are removed. That would be bad news, since historically housing is one of the key locomotives pulling the economy out of recessions. While absolute housing inventories (both new and used) are now relatively low, relative to sales they are still very high — if not as awful as earlier in the year.
I still fear a big second wave of foreclosures will add to those inventory levels. Mortgage delinquencies are still rising, and unemployed people in houses that are worth less than the amount of the mortgage have every incentive in the world to simply walk away from their house, or simply live rent and mortgage free until the sheriff shows up at the door. This is one of the key reasons that I expect the economic recovery to be very anemic, especially after a short-term inventory bounce is out of the way.
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