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Conor,

There is new data today regarding weak jobs growth in the US.

REUTERS US stocks fly; jobs data may mean end of rate hikes
By Ellis Mnyandu
NEW YORK, Aug 4 (Reuters) - U.S. stocks shot higher on
Friday as a government report showing weaker-than-expected
July job growth increased expectations that the Federal
Reserve will decide against raising interest rates next week.
Optimism that more than two years of Fed rate increases
may end soon underpinned gains in the shares of interest-rate-sensitive companies, including banks, insurers and home
builders.
"The Street believes the Fed's out of the way. We can now
go on with the process of healing the economy without higher
interest rates to come," said Barry Hyman, equity market
strategist at EKN Financial Services Inc. in New York.

I'm still giving 50-50 odds on hard-v-soft landing at this point. I think one or two more rate hikes could well have tipped things towards hard landing. But with a halt and even a slight chance of cuts if a recession fires up soon enough, the credit cycle could be extended by another two years easily. In that case we won't see a return of flippers and specuvestors as real home prices will keep dropping, but we probably also won't see ARM resets driving out near as many homedebtors, as they'll just keep refi'ing into further-out ARMs -- especially when those refis will be sold with a "take advantage of falling rates" spin.

Batten down the inflation hatches.

DinOR,

I'll take that glass of water now. And some alka-seltzer if you've got it.

Conor,

I'm not a permabear either, but I expect the worst of both worlds:
Real deflation of US wages and real inflation of cost of living (energy, food, imported goods, etc...). This should be tempered somewhat by the reduced cost of housing as a percentage of disposable income, IMO.

Our currency is backed by our military, which is simultaneously bloated and overstretched. This middle east situation could get ugly really fast, which will not be good for the dollar (not to mention our massive credit bubble, etc...).

Randy H,

Coming right up!

Conor,

Given the most recent opinions of the O.C.C I get a sense that a tightening of lending standards has absolutely got to take place before we can even discuss rate reductions. (God, I can't believe I just said reductions). I understand Bill Gross has already come out today at the open and said no hike on Tuesday (for those that follow BG).

Conor or Randy,

What do you make of the 4.99% yield on the 30 year? Doesn't seem like the market expects hyperinflation.

Even if the fed starts cutting again, they may be "pushing on a string." Hard to get anyone to borrow when they are all already in debt up to their eyeballs. Having learned their lessons, many homedebtors would use the opportunity to switch from ARM to fixed, but there are too few underleveraged new buyers to really get the speculative juices flowing again, IMO...

Interesting that the next rate cut cycle will be coinciding with the new restrictions on lenders... I'm guessing that the stricter lending standards will drive down demand just as the housing supply is topping out. If I'm right, it may be possible to get a much cheaper house *and* a low mortgage rate within the next 4-5 years (ie: back to '01 or '02 prices and rates).

Conor,

Just my gut, but I don't think the rate easing will reignite the RE bubble. RE has played out for a while. My guess is that defaults and foreclosures will keep rising, the media will keep lagging and talk about lots of desperate souls forced out of their homes for quite a while.

Newly abundant credit will seek out a new victim. Probably in stocks for a while, maybe a good bit into commodities too. Maybe the next big scandal will be people investing in narrow ETFs inside of their tax-deferred accounts. When Joe Sixpack ends up with all of his retirement in gold and silver ETFs you'll know its definitely time to run not walk. I kind of doubt that, actually, but it wouldn't surprise me. Instead I think we're in for just another sector stock-bubble which starts pulling up the entire market. Techs have been inexplicably bullish of late. GOOG 2,000 anyone?

Bernanke has said that rate decisions will be "data dependent" and that we need to wait until the last round of rate increases is absorbed by the market.

I am no expert, but here is my two cents: I think a pause is virtually certain. Maybe a long pause (like 4 or 5 meetings). Then, if inflation is really undeniably taking hold and/or the dollar is crashing, the Fed will tap the brakes again. But if inflation is "well contained" and the economy is softening, the cuts can get started...

Glen,

No one who's serious or respectable expects anything one could label "hyperinflation". Some expect stiff inflation -- something like maybe 10% per year. Hyperinflation is 1% per day.

Fed will raise rates to slow domestic, realized consumer inflation as in PCE. They don't care about the dollar. The dollar is actually a very complex issue. In many ways a weakening dollar is tremendously advantageous for the US. It creates domestic jobs, increases exports, narrows trade and capital flow balances, reduces government debt burdens, and puts pressure on any country pegging to the dollar. Anyone who keeps their dollar pegs (to fight off losing their export-to-US cost advantage) is effectively taking inflation off our hands and eating it themselves. So, we don't even pay the full cost of the inflation we create.

Many believe that a pause is a sure thing, but I believe if there is a pause, inflation will take off like a rocket. Missing 4 - 5 meetings is not going to happen. As rents rise (which are a part of core CPI), inflation will continue to grow. The CPI has been rising steadily since the beginning of the year. Inflation is not under control!

tannenbaum,

Nice recap of rates. I believe you're right, any reductions in the near term will not provide the salvation DL and FB's so desperately seek. All it can possibly do is quell the panic and hopefully prevent too many FB's from "just dropping off the keys".

Incentives for them will not include pools, pergraniteel or anything of the like. It will be more along the lines of: Re-fi NOW to a FRM and get a free case of Top Ramen Noodles! (Why do I get myself so worked up about this stuff)?

Allah,

I agree that inflation is not under control. But that's why I think the Fed will pause, rather than cut. They can get away with this if they continue to talk tough on inflation, while claiming that inflation is contained.

They can get away with this if they continue to talk tough on inflation, while claiming that inflation is contained.

From what I read, they aren't claiming inflation is under control and if hint that they are finished much less decrease rates, the dollar will crash very hard. There are many who are about to dump the dollar, myself being one of them!

Conor Says:

Randy, 50/50 sounds about right. The key for me is how economic actors will respond once the Fed finally does cut rates again. Will people embrace risk-taking anew? How will they express this view? Stocks? Real estate? Commodities? Obviously, the housing bubble created a lot of the prosperity we’ve seen over the past few years, so if we could create a new bubble perhaps we can have a soft landing for awhile.

The other economic "actors" to consider are foreign investors and how possible near-future rate cuts would affect thevalue of the US dollar, the bond market, and commodity prices. If the Fed goes soft and starts cutting rates again soon, these players will not like it. I would imagine these considerations are as important if not more important than the herd of mass investors looking for the next asset bubble. Maybe I'm just being naive.

Conor,

Definitely some pass through from rising real oil prices, and a significant source of inflation. But the US imports a fairly small portion of oil from currency risk sources, and even with those will still enjoy a reserve currency status for at least 10-15 more years. The ECB helps ensure that with their policy -- the ECB does not want a disorderly appreciation of the Euro which would come with a rush to petroeuros. That would kill their ever anemic export-driven recovery.

Meanwhile the US is (in my opinion unwisely, for other reasons) plowing forward with a policy that will result in domestically produced corn & beans increasingly taking the edge off of foreign currency exposure to crude. Add to that the far less currency exposed sources of crude from which the US largely draws.

These equations are far from linear. There may well be an ultimate day of reckoning. I just contend that no one here or elsewhere is likely to guess it with any accuracy.

The missing piece of the puzzle is FISCAL POLICY. I sometimes think everyone forgets there are 2 seats in the cockpit. The pilot is the Congress/Executive with Fiscal. We've just decided the pilot is drunk and we'll let the co-pilot fly this bird.

The stock market is completely confused about the rate hikes. The thing has now turned south. Even the Gold market is very tentative on rate hikes.

The stock market is fixated on the rate for the short term. Given that they have almost concluded that Fed won't hike, we already had some short rallies. I am betting the gains are priced in. If Fed pauses as expected, it will not start any rally. But if the Fed shocks, there might be a strong decline.

Hence I have made some short term bets on the downside. Let's see.

The feedback loops and various branching points are extremely interesting.

Fed stops the hikes, not just pause. Then reduces the rates soon. Maybe the $ weakens. That might push up inflation and/or long term rates. It reduces consumption. That hurts economies that export to US. Which might reduce the oil demand, and stabilizes oil, keeping inflation in check.

This is just one of the many scenarios. Seems more like weather predictions.

Is Chaos Theory used in economic modelling ?

Re: Listings

I love this little trick by realtors where they list a home as having 3 beadrooms, however upon further investigation, you come to find that the house isn't a true 3 bedroom home, but rather a 2 bedroom home that can be converted into a 3 bedroom house.

Makes me laugh when I think back to those RE sponsored commercials where they dressed some actor up in a suit who said - As a realtoooor, I have high ethical standards to live by, you can trust me, etc. Please, the lack of ethics in this industry is a joke (which really isn't funny).

I can just imagine the training that goes on within the walls of Century 21 where they probably have some sales manager stand in front of a bunch of new agents and says - Okay people, just remember, there is the truth and then there is the "truth".

Is Chaos Theory used in economic modelling ?

Have you read The Misbehavior of Markets by Benoit Mandelbrot?

Is Chaos Theory used in economic modelling ?

There's a reason neural networks are so popular when it comes to modeling this beast. Too many interrelated moving parts. Feedback loops within feedback loops which affect other feedback loops inside of other feedback loops.

But just imagine someone who was born and raised in California? All they’ve ever knows is nice weather, an expectation of good cuisine, and higher salaries? The way I look at it, there are people like my brother who has never left TN, thinks it’s the best place in the world, hates going to NY where his GF lives.

That strikes too close to home.

Basically the problem is that Californians think that California is the center of the universe because they can't leave California no matter how many hours they drive, and because they're too cash strapped to visit other places.

In reality, it's universally understood that New York is the center of the universe. But Californians will never understand because of Californiatitis (the swelling of the California in the brain.)

Thought it would be back at 1997/1998/1999 levels of 2-3% with the “google” effect and Web 2.0 and all!

That, stabilized interest rates, continued money flowing out of google - Mountain View condos to start at $500k for a 1br/1ba by end of the year. (Pretty close already...)

No one who’s serious or respectable expects anything one could label “hyperinflation”. Some expect stiff inflation — something like maybe 10% per year. Hyperinflation is 1% per day.

Fed will raise rates to slow domestic, realized consumer inflation as in PCE. They don’t care about the dollar. The dollar is actually a very complex issue. In many ways a weakening dollar is tremendously advantageous for the US. It creates domestic jobs, increases exports, narrows trade and capital flow balances, reduces government debt burdens, and puts pressure on any country pegging to the dollar. Anyone who keeps their dollar pegs (to fight off losing their export-to-US cost advantage) is effectively taking inflation off our hands and eating it themselves. So, we don’t even pay the full cost of the inflation we create.

I completely agree and have been arguing this for some time. Those who believe that the Fed would actually tighten enough to allow (broad-based) deflation to take hold simply haven't been paying attention or considering this thing from a Washington D.C. risk/reward perspective. High (but not hyper) inflation is the path of least resistance to both Fed and the politicos it serves.

It's a safe bet they will continue to talk tough on inflation while doing precisely the opposite. How long it will continue keep our international rate & credit swap shell game going is anybody's guess though. Conor's scenario of successive waves of "raise-then-lower" rate cycles (but peaking lower on each successive cycle until you can no longer raise) sounds plausible.

With trends towards slowing jobs growth and indicators showing persistent inflation, stagflation seems to be the most likely outcome of all this. In my simplistic view of this, I wonder why the markets are so gleeful that the jobs numbers are tepid? So what if these numbers give the Fed an excuse to pause next week? The Fed is in a pickle no matter what they do. They can try to just "hold the course" and keep rates in this "neutral" zone, they can continue raising rates to beat the crap out of inflation expectations, or they can start lowering rates soon to rehash the lame attempt at "stimulating the economy." As I see it, at least for the myopic perspective on the housing market, none of this is very good. Raise rates more, and the hard landing scenario seems more and more likely. Keep rates in this "neutral" zone, stagflation persists, no one can afford anything as wages are flat and prices continue to go up. Lower rates, and inflation gets out of control. Pick your poison, BB!

Have you read The Misbehavior of Markets by Benoit Mandelbrot?

No. I have only read his book on his Fractal Geometry. Which was 15+ years ago, so I only remember a few things. Is it worth reading ?

MA,

When we pondered earlier what sector/asset class might be the new beneficiary of possible "rate reductions" I was hoping someone might have said, innovation?

There are still so many unresolved issues here and abroad that should demand our full attention and best efforts but as a country we seem to have abandoned innovation and are now perfectly content playing "round robin" from one established sector to the next.

*For those that have never played in a "round robin" tournament, no one is ever really eliminated, every team plays every one else at least once and in the end trophies are awarded to everyone for "participating".

Is this what we want?

No. I have only read his book on his Fractal Geometry. Which was 15+ years ago, so I only remember a few things. Is it worth reading ?

It is not bad.

HARM,

I too praise Conor's cyclical assesment. Why not? It's "worked" so far? The best part is that it keeps the California Real Estate Lottery System well intact. You lose? Better luck next cycle!

Peter,

I read Mandelbrot's book. It is a good one, though I think his central thesis can be stated fairly succinctly: Markets routinely and systematically underestimate the frequency and severity of "fat tail" cataclysmic events.

This is just one reason why I tend to discount the importance of mathematical modeling in finance. Every once in a while, a category 5 event occurs, which makes all of the models irrelevant. If there is a derivatives meltdown and/or severe and sudden dollar crash, I hope to avoid it.

The best part is that it keeps the California Real Estate Lottery System well intact. You lose? Better luck next cycle!

Have you watched The Island? Whoever wins the lottery gets to go to "the island".

A fat tail book I liked better is “Fooled by Randomness.”

I have two cats with fat tails. I do not need more reminders. :)

Michael,

I liked that one better too. Though it made me acutely aware that I am a fool for checking on my investments daily.

He’s second to Stephen Wolfram in self-love, however.

Wait, I rediscovered this cool little computer game called "Life". Eureka! It's a whole spanking new kind of science.

I am glad we are talking about what happens after Fed pauses. Hardly anyone else is doing that.

The Fed pause, this time or next time, is almost certain. It's boring to discuss that. So far, I am hearing a consensus being developed here towards -

1. Fed pauses, and most likely drops rates, in a year, or earlier.
2. That doesn't help RE prices anyways, but merely slows down the decline.
3. Short term inflation in stock prices and/or commodities
4. Longer term decline in US$
5. Consumer price inflation (actual, not voodoo) for the foreseeable future

If this plays out, there is systemic risk introduced. What happens to the "entitlement programs" as talked by US Treasury Sec ? Deficits of all sorts will increase. Will it lead to higher taxes or eventually the Fed will be forced to hike rates ?

There doesn't seem to be a way out. Unless some epoch making change happens (like Internet in the 90s) and productivity shoots up. But what if it doesn't ?

DinOR,

I am actually a optimistic about innovation for at least a few more cycles, which is effectively most or all of my lifetime. I'm a bit more cautiously optimistic that this will continue well into my children's and grandchildren's lifes as well.

There are indeed still a huge number of problems that need solving. Energy, medtech, biotech, agritech... Hell, even the tired old problem of software and IT hasn't been adequately solved yet. The number of people who believe their IT world is adequate and needs no further improvement please raise your hands. Why the hell does Windows get a little slower every freaking time I use it?

Wait, I rediscovered this cool little computer game called “Life”.

Is it an MMOG? :)

George Says:

I personally think the next bubble is going to be in gold.

Unless there's a sea change of attitude towards gold and ease of purchase/transaction, I don't see this happening on nearly the same scale as internet stocks, housing or even beanie babies. Your average sheeple just won't have the sophistication and access to gold markets to make this happen. This is, of course, unless people start buying decorative gold and jewellry. It may very well happen in with the investor crowd, though.

You mean people won't discover the GLD, SLV, DBC etc ?