It’s not about inflation; it’s about taming the real estate bubble.
Or so opines Ed Yardeni in his latest missive to clients. The chief investment strategist at Oak Associates writes that the Fed’s hiking interest rates these days because of worries of a “speculative bubble” in real estate. Inflation per se, by contrast, isn’t the trigger this time around in the tightening of the monetary screws.
It’s an interesting theory, and one that an open-minded investor shouldn’t dismiss out of hand. But at the end of the day one might ask, does it matter? That is, should an investor care if the Fed’s elevating rates because of real estate vs. inflation, or flying saucers, for that matter? An interest rate hike by any other name would sting no less. And while we’re at it, one might also wonder, is there really that much difference between a housing bubble and a traditional rise in inflation?
For those inclined toward a monetarist’s view of the world, the money supply is the start and end to all such questions. And at the moment, there’s too much supply floating about, to judge by any number of traditional measures. The Fed funds rate is currently 2.75%, and it doesn’t take a professional economist to recognize that two-and-three-quarters looks pretty low next to, say, the rate of real annualized GDP growth (3.8%, at last count) or the real (inflation-adjusted) Fed funds rate (-0.25%, using the latest CPI number for adjustment).
Regardless, some of the money that’s being printed by our friends at the Fed is finding its way into housing, to understate a trend. In a sign of the times, blogs dedicated in whole or part to outing the real estate bubble, real or perceived, are a growth industry, as Corante observes. Among the pithy observations found in the associated travels among property oriented blogs is this little gem from Curbed: “To summarize our philosophy: of course there’s a bubble; you can’t do anything about it; go ahead, keep buying; see you in hell!”
Meanwhile, let’s assume for a moment that Yardeni’s right about the Fed’s motivation for raising rates. If so, a logician might continue, it’s only fair that the Fed clean up the bubble since it was the central bank that created the mess–a talent, by the way, that’s no stranger to the maestro’s regime, in any number of asset classes. Or so John Makin of the American Enterprise Institute suggests (for real estate, that is) in an essay published Monday. Cleaning up the mess, he counsels, is no great mystery, but it’s hardly painless: “The Fed should eliminate the ‘measured pace’ language from its statement,” Makin argues, “and simply indicate that monetary policy is currently accommodative and that accommodation will be removed at a pace dictated by the future path of growth and inflation.”
But that’s not so easy. Inflation, after all, may be accelerating, in which case the Fed may have to raise rates substantially and sharply to keep pace. In short, 25-basis-point hikes may soon give way to something more ambitious.
Does the cure then threaten to be worse than the disease, at least in the short term? As Yardeni explains: “The problem is that if they raised the Fed funds rate more aggressively, the bond market might actually rally! The Bond Vigilantes might actually cheer that tougher monetary policy will probably keep inflation at bay. It might also burst the housing bubble and send the economy into a recession.”
There was, in fact, a whiff of cheering today in the bond market. Traders were in a buying mood, relative to recent sessions, and the yield on the 10-year Treasury Note slipped to roughly 4.58%, the lowest in a week.
As for a bursting of a housing bubble, assuming it exists, the jury’s still out, but the second-guessing goes on. To be fair, some of the commentary attempts to explain away the fear that a real estate bubble is upon us. Among the arguments advising that panic is unfounded, unnecessary, and unenlightened: real estate, unlike stocks, has perennial, fundamental demand, i.e., we all need to live somewhere. Stocks, bonds, and Picassos, by contrast, we can all do without, and from time to time that’s reflected in the prices.
But while there’s an intellectual case to be made for erring on the side of optimism on real estate’s bubble, er, bull market, there’s a reason to sleep with one eye open, and MaxFunds.com, captures the sentiment succinctly: “The main reason investors should worry about real estate bubbles is this: most experts say that real estate bubbles are simply impossible.”