Weekly inflation outlook: the tide is rising
This article was written exclusively for Investing.com
Thursday’s report highlighted, with a relevant example, exactly what I have been talking about recently. Growth does not cause , and recessions do not cause disinflation; so while I’m negative on the outlook for growth, I don’t expect that to help quell the fires of inflation.
Last week’s existing home sales report was disappointing, confirming justified fears among homebuilders and real estate agents that higher mortgage rates and a slowing economy would discourage traffic and turnover . By now you know that home sales rose at a seasonally adjusted annual rate of 5.61mm, which was below expectations and the lowest since months of the pandemic shutdown. While that would still be a relatively healthy rate compared to the pre-COVID era, there is no doubt that rising interest rates are slowing turnover.
This effect is one of the most obvious ways in which higher interest rates cause economic activity to slow down, and is clearly an intended outcome of the Federal Reserve. Slow down the scorching housing market and calm house price inflation. Well, one out of two isn’t bad.
The April house price increase was +4.38% month-over-month, keeping the year-over-year figure at +14.8%. Now prices in the housing market are very seasonal, but still: April 2005 and April 2013 were the only years this century where m/m gains in April were higher. The first of these years was when the real estate bubble was inflating; the second was when they rebounded after the bubble collapsed.
The following chart from Bloomberg shows the m/m changes, by calendar month, over the past 5 years. The thin blue line at the top is April’s m/m gain.
So home Sales were weak, at home the price the increases remain very strong. True, they cannot continue at 15-20% per year.
But the important point is that the link between home sales and home prices is tenuous at best. In housing, there are at least two reasons for this, and one of them applies to markets in general. The first reason, which I alluded to, is that the first impact of higher mortgage rates is felt on the most price-sensitive buyers. But the main reason is that as long as the overall price level itself continues to rise rapidly, the nominal price of any fixed asset should also continue to rise.
the price level exchange. A 14% year-on-year increase in house prices when inflation is 8% is equivalent in real terms to an 8% increase when inflation is 2%. We look at 14% and say “wow”, but that’s because we’re staring with “2% inflation” eyes. Since 1999, median house prices have risen at an average rate of about 2.3% per year relative to the rate of inflation, including the boom and bust of the 2000s. The current real rate of increase in 6%, while unsustainable in the long run, doesn’t strike me as completely outlandish. The thing to remember is that “2% eye inflation” is not the right frame to use.
However, there is no doubt that sales, which are expressed in units and not in dollars, are down. The Fed succeeds in slowing down the economy. And if, in fact, Chairman Powell is true to his word and the Fed goes ahead and risks a hard landing, then we will have a good, hard landing. (I remain skeptical that the Fed will be so cavalier if stocks continue to fall and stocks start to rise, but I also admit that I thought they would concede in this game of economic chicken before now.)
Take a step back…
Remember that the price level changes and your “2% inflation eyes” will deceive you from time to time. As I have pointed out in other contexts, even though “peak house price inflation” is probably behind us, that does not mean that house prices are due to decline.
Money is worth less now than it was before the crisis because there is so much more of it. Since 2010, M2 has increased by 148%. House prices have only increased by 122%.
The graph below (Source: National Association of Realtors, Federal Reserve; Enduring Investments calculations), indexed to end-2010, does not seem to suggest that house prices are likely to fall in nominal terms – and I measured the rise from the bottom of the post-bubble trough.
The chart is also interesting because it seems to show a nice inflection in house prices around the time we got a nice inflection in money supply growth. What a coincidence, right?
You can repeat this exercise for all kinds of assets and consumer items. What we see in housing is a decline in unit sales, but a continued rise in prices. In the economy, in generalwe’re starting to see a decline in unit sales growth – which is another way of saying real growth – but a continued rise in prices.
When we hear companies on their conference calls talking about the evolution of sales, we hear them talking about two things. Dollar sales growth is the change in unit sales combined with the change in unit price. They are two different dials and they are affected by different things. It is quite consistent, if the overall price level is increasing, to see a decline in unit growth as the unit price continues to rise. GDP is measured in real units.
In a nutshell, this is why we are very likely to get a contraction in the real (ie a recession) while continuing to observe inflation. Good job, Fed. As Geddy Lee once sang, sometimes angels punish us by answering our prayers.
This does not mean that all prices will rise at the same rate, or that Nope prices will retrace part of the post-COVID peak. But it is very important to recognize the difference between changes in relative prices (some increasing faster than headline inflation, and others more slowly) and changes in the absolute level of prices. Different product prices will fluctuate. These are waves. The price level itself is the tide. The tide is rising. Move your castles higher on the sand.
Michael Ashton, sometimes known as The Inflation Guy, is the Managing Director of Enduring Investments, LLC. He is an inflation markets pioneer with a specialty in defending wealth against the onslaught of economic inflation, which he discusses on his Cents and Sensibility podcast.