THE LOCATION STRATEGY TOP 10

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MARK YOUR CALENDAR

Scott Davis will be speaking at the North Houston Counties Builder Association meeting on December 7.  We’ll post the link as soon as it available.   This will be your only chance this fall to hear Scott’s public presentation on the state of the market.

HOW HIGH CAN IT GO?

Stanley Druckenmiller said that whenever the CPI has reached 5% or higher that it hasn’t come down until the Fed Funds rate has risen above it.  He goes on to say he thinks it is unlikely that rates will go that high because of the economic devastation that an 8-10% Fed Funds rate would cause makes that untenable.

We took a look at Druckenmiller’s claim with data going back to the 1950s, and he’s generally correct.  The only time this did not hold was in October 2008 when CPI peeked just above 5% and then followed earlier Fed Funds rate decreases to 0, and briefly went negative.

FIVE BELOW

The CPI is running about 8.2% which would suggest a Fed Funds rate higher than that level to bring inflation back in line with targets.  Current forecasts call for topping out around 5% -- but then we saw last week just how good our economic experts where at forecasting.

FACTORS THE FED WILL CONSIDER

Given the sizable contribution of labor costs to inflation (through services), the Fed would like to see the openings-to-unemployment ratio closer to pre-COVID levels, but it’s not budging for now. There are roughly 10.7 million job openings in the US right now – returning to pre-pandemic would mean either eliminating 5-6 million jobs or somehow finding 5-6 million additional workers.   I can’t imagine where we might find millions of excess workers. In either case, this does not look like a signal to “pivot” and argues for a persistently high Fed Funds Rate.

Excess savings remain high for the upper income quintile.   Savings are going down for all groups – but are declining the slowest for high income households. This is still driving all kinds of spending, although those spending categories are generally starting to come down

One of the places that excess savings continue to go is into the housing market.  As new home construction declines, we should see continue spending go into home improvements.  This, along with the demographics of buyers and sellers, is one of the reasons we’re recommending renovation operations if that’s something your company can feasibly do.

We see new housing hurting more from the vastly reduced excess savings of other income groups.   Purchase money mortgage applications are at 2014 levels.

Another factor we see influencing how high rates will go frankly is policy error.   Actual rents have now declined two months in a row – the first such decline in several decades, and yet the Fed persists on relying on continued increases in its own “owner’s equivalent rent” which long-time readers will recall is a garbage measurement based on telephone surveys that ask homeowners what they think their house would rent for.  Besides the obvious methodological problems, the OER also lags the actual data by almost six months.  So you can count on the Federal Reserve to continue fighting home price inflation for months after actual home price inflation has long disappeared.

The Owner's Equivalent Rent is not the only questionable metric used by the Fed, but the next one may actually work in the housing industry's favor. The Federal Government tracks employment in two surveys: the Establishment Survey and the Household Survey. Establishment survey is the data you hear on Friday mornings about job growth and reflects payroll numbers. The Household survey counts actual employed workers and supplies the national unemployment rate data.

You can see in the chart below the two surveys are in unison until March 2022 when they begin to diverge. What this chart shows is that the Household survey only shows an increase of 150,000 from March to October, while the Establishment Survey shows employment increased by 2.5 million! I would expect that we will see some adjustments to the survey data post-election bringing those job numbers down reflecting recent tech layoffs and also the affect of interest rate increases already in place - which would mitigate against higher rates for longer periods.

These are the reasons that we believe rates will probably end up going higher than 5%.   Once they are there, how long should we expect them to remain high?  

Back in the 1980s, Volcker’s action took years -nearly a decade -  to work itself into inflation expectations.

The US experience is not unique.  Deutsche Bank analyzed 50 years of economic data for 50 countries who have experienced inflation greater than 8%.  The chart below shows the historical ranges of inflation in these countries (0 axis is 8%).  The dotted lines are the current forecasts for inflation in the US.

The data show that inflation was persistently high for long periods of time – suggesting that the current forecasts showing inflation ending (conveniently enough) just before the presidential election in 2024.  A more realistic outlook suggests that we will see high inflation and high interest rates for longer than the next 24 months – especially because the study’s authors note in almost all of these historical situations, central banks took action against inflation before it hit 8% - unlike the US here – and they haven’t usually loosened fiscal policy during the fight as they are now doing in Europe because of gas shortages there.



In sum, I can exactly say how high we think rates will go or how long they will stay there – but I am pretty sure that they will go higher and for longer than we are presently being told.

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