Inflation and Home Prices
The market's bid to break its 6-week string of losses is back to square one. The EU promised to have a solution for Greece hammered out this month. It's clear now that Greece is going to do a polite default. That is, its debt will be restructured so that current bond holders take a haircut and receive new debt designed to give Greece a little breathing room.
But so far, they can't agree on how to structure the deal.
That's creating uncertainty for Greece, but also for the other European countries with debt problems. Will Ireland and Spain be allowed to restructure debt as well? Europe says "no", even though it is setting a precedent with Greece.
*****More important for the U.S. stock market, the Empire State Manufacturing Index came in much weaker than expected. Expectations were for a 12, and the Index came in at -7, the worst reading since November, shortly after the Fed started QE2.
Clearly, this index shows that manufacturing has weakened, and underscores the fear that the economic recovery is not exactly surging ahead.
*****It's not all gloom out there. The Mortgage Bankers Association (MBA) says that mortgage loan applications rose 13% last week. Most of the gain was for refi's, not outright purchases, but this is still a positive as lending has been a drag.
Of course, the gain is for just one week. And the fact that refi's accounted for the majority of the improvement can be directly credited to the steady decline of low interest rates. 30-year mortgage rates fell to 4.51% last week.
It would be much better if there was evidence of rising demand for homes, but alas, that will have to wait.
*****There is a direct link between housing and the Consumer Price Index (CPI). It's not often mentioned, but the continued decline for home prices has helped keep a lid on inflation as measured by the CPI.
And the recent decline in gas prices also helped the CPI come in at a 6-month low of 0.2%. Food costs rose 0.4% and clothing rose 1.4%, while energy prices fell 1%.
So, we are seeing inflation for necessities while the overall inflation number is being deflated by housing. This is something to pay attention to, because a rebound for housing prices will be our first indication that inflation measures like the CPI will start moving above the Fed's target level of 2%, and rate hikes may be coming.
Don't miss the irony here: interest rates and mortgage rates will stay low so long as housing demand is weak, thereby supporting the recovery. But the minute there is actual demand for mortgage loans, rates will rise.
(And of course, it is continued mortgage issues and the potential for an even weaker housing market that is weighing on the financial sector right now.)
Robert Shiller, Yale professor and co-creator of the Case-Shiller home price index, says that housing prices could fall another 10%-25%. But he also acknowledges that such forecasts are very difficult to make.
The one thing we do know is that home prices aren't improving anytime soon.
*****QE2 officially ends in 5 days. And it appears that investors have largely positioned themselves as we expected they might: selling stock and buying Treasuries.
From the start, QE2 was designed to push investors into the stock market. And now that it's ending, investors have been leaving the stock market. The question now is: will that continue after QE2 officially ends? Or might June 20 be the end of the current correction?
We'll see, soon enough...
*****As always, feel free to write me anytime: dailyprofit@wyattresearch.com
