Chuck Ponzi May 18th, 2006

The LA Times posted a great piece today regarding a hotbutton of Fed interest rate policy; Inflation.

Yes, the crazy reason that metals are screaming (even this week’s dump of nearly 5% in one day) and we have people worried has reared its ugly head. Those who thought that the FED would be done raising rates or at least take a pause should probably wait a little while before calling their bookie.

Like an uninvited drunken uncle, higher consumer inflation crashed the economy’s growth party Wednesday. But it wasn’t just higher energy prices that caused concern. Rising rents and higher prices for a wide variety of consumer goods, including prescription drugs, swimsuits and school books, were key factors behind a higher-than-expected 0.6% increase in consumer prices in April. The inflation news, reported by the Labor Department, sparked a stock market sell-off amid fears that it would lead to higher interest rates and an economic slowdown.Higher rents in particular were worrisome, accounting for nearly half the surprisingly high 0.3% increase in the core consumer price index, which excludes energy and food costs. Rents have been increasing as many people are priced out of the sky-high home purchase market.

If you missed the market sell off, it was quite painful, including a 200 point bender for the DOW. Talk about crashing the party, the FED still has to take away the punchbowl.

Many of these rent increases and other higher prices could stick around because they aren’t dependent on energy and don’t necessarily respond to Federal Reserve interest rate hikes, economists said.The spread of price hikes to nonenergy areas “suggests that inflation is now a greater risk for the economy,” said Lynn Reaser, an economist for Bank of America in Boston.”It’s still moderate,” she said. “But this report does suggest that if the economy moves closer to full capacity, with the unemployment rate at 4.7%, this could be the beginning, perhaps, of a little more hint of a pickup in inflation.”

Too bad for us. Higher prices are here to stay. It’s only a matter of time before these higher prices start impacting consumers; notice, noone has mentioned wage inflation yet. Still, there seems to be much less in the MSM about offshore outsourcing than in the past few years. That means it is either slowing or we’ve become more accustomed to it and boring news doesn’t sell newspapers.

Mark Zandi weighs in on the topic:

It also was another sign that the economy is shifting gears, perhaps into a phase where growth slows and inflation rises simultaneously, said Mark Zandi, chief economist for Moody’s Economy.com.”We’ve enjoyed an economy that’s been expanding very strongly,” he said. “The next couple of years aren’t going to feel nearly as good as the last couple.”

He just mentioned stagflation! The question is whether Bernanke will allow this to run its course for a few years and play dumb when we have substantial inflation, or if he squashes it proactively. Is he a hawk or a dove?

Relating to the housing market, we have a great little cherry bomb at the bottom:

“There is real pressure to rent now because people can’t afford to buy,” said Delores Conway, director of the Casden Forecast.Rising mortgage rates also are giving landlords more incentive to boost rents. When rates were low, Southern California landlords were afraid to raise rents because mortgage payments were comparable to rent costs, said James Joseph, a Century 21 brokerage owner who specializes in the apartment market.” That timidity is disappearing,” Joseph said.

I’m glad we found a way to mention for-sale housing because I was getting worried that we’d forget about the thing running our economy in the southland. The question is not whether rents will go up (they will), but how fast prices will come down to meet them. The presumption that rent rates are comparable to mortgage payments is surprisingly misinformed.

Our replacement for Scary Gary has arrived. Bruce Norris, at TNG is keeping it real from the IE. His recent article in Forbes is well structured, points out the critical mass that we have reached.

“The word ‘bubble’ has been used so often it has lost its significance. Many economists scoff at the idea while others have been waiting for this over-priced real estate market to ‘crash’ for years. Somewhere in the middle lies the truth and the consequences will be felt by hundreds of thousands of unsuspecting real estate owners. By the end of 2007, no one will need to ask if there had been a real estate bubble.

“Here’s how the California market will make the transition from boom to bust as outlined in our new report the California Crash. It starts with affordability getting too low. When so many people can’t afford the monthly payment, our market loses velocity. Because of that we sell less real estate. The first sign of this happening will be growing inventory of available homes for sale. Inventory has already doubled between 2005 and 2006, going from a 3.3 months supply to a 6.7 months supply. The good news is that the inventory is still mostly owned by people, not banks. That will soon change. “The increase in inventory happens to the builders as well. They have a tougher time selling homes and offer discounts, incentives and cooperation with brokers. The bottom line is that the ‘mood’ will have changed. Unsold inventory means less homes being built in the future. This creates a domino effect because the builder has to lay off workers. What does a drywall hanger do if all of California slows down? Most likely he’ll move to where he can find work. That’s the final nail in the coffin for a real estate market: negative net migration. When an area loses people, demand is gone and so is the artificial “stimulus” that caused the price boom in the first place.

Bruce, thanks for giving us the historical perspective from 1997 to today in your article. You can visit him and his office staff at their website, or drop by their blog for a quick roundup of other southland real estate news.

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