Death Star? Fed Seems Resigned to Bubble Risk in Effort to Extend Expansion (Declining R-Star)

Asset bubbles abound thanks to Central Bank low rate policies. And these aren’t tiny bubbles, but gargantuan asset bubbles.

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(Bloomberg) — Some Federal Reserve policy makers seem resigned to running a heightened risk of asset bubbles and other financial excesses as they seek to keep the economic expansion going.

That’s one of the messages tucked inside the minutes of the Federal Open Market Committee’s March 19-20 policy making meeting.

“A few participants observed that the appropriate path for policy, insofar as it implied lower interest rates for longer periods of time, could lead to greater financial stability risks,’’ according to the minutes, published April 10.

Chairman Jerome Powell could be one of those officials. He’s publicly pointed out that the last two expansions ended not in a burst of inflation, but in financial froth, first a dot-com stock market boom, then a housing bubble.

A willingness by the Fed to court such perils by holding rates down should be good for the economy for a while. After all, the aim of such a policy would be to sustain growth at a healthy enough clip to meet the Fed’s twin goals of maximum employment and 2 percent inflation.

But that monetary stance could store up trouble down the road should the financial threats materialize.

“Easy financial conditions today are good news for downside risks in the short-term but they’re bad news in the medium term,” senior International Monetary Fund official Tobias Adriantold a Boston Fed conference last year.

In economists’ parlance, here’s the Fed’s dilemma: R-star — the neutral interest rate that stabilizes the economy when it’s meeting the Fed’s goals — may be so low that it also prompts super-risky behavior by investors.

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Behind the fall in R-star: an aging population and slower productivity growth that has boosted savings and depressed investment.

Catch a falling star? Or is it a Death Star?

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Bring Out Your Fed! Existing Home Sales Fall -5.44% YoY In March (EHS Inventory Lowest Since 1999)

Bring out your Fed!

According to the National Association of Realtors (NAR), existing home sales tanked -5.44% YoY in March.

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At the same time, the INVENTORY of existing home sales rose in March, but still remains near its lowest level since 1999.

Existing home sales Median Price YoY has slowed to 3.8% with The Fed’s quantitative tightening (QT). As opposed to 13.4% YoY during The Fed’s QE3.

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Time to bring out your Fed!

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CRE Bubble? Commercial Real Estate Prices Since The Financial Crisis (Apartments Have Largest Run-up, Retail Has Poorest)

Given the advent of on-line shopping, commercial real estate prices are not quite back to where they were at the height of the asset bubble prior to the financial crisis of 2008-2009. Suburban office space is barely above the pre-crisis peak.

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On the other hand, apartment prices are substantially above where they were in 2008-2009, as are CBD (Central Business District) offices.

All with the help of The Federal Reserve’s low interest rate policies. But notice that the growth rate of CRE has slowed (except for apartments).

The good news for CRE investors? The Fed isn’t likely to keep raising their target rate or continue to shrink their balance sheet.

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US Housing Starts Fell In March, Slowest Pace Since May 2017 Despite Interest Rate Declines (5+ Unit Starts Decline 3.44%, 1 Unit Starts Decline 0.38%)

The hopium about interest rate declines didn’t pay off in March. Housing starts fell despite declining interest rates.

(Bloomberg) —  U.S. new-home construction unexpectedly fell in March, decelerating to the slowest pace since May 2017 and suggesting builders remain wary even as lower mortgage rates and steady wage gains offer support to consumers.

Residential starts fell 0.3 percent to a 1.139 million annualized rate after a downwardly revised 1.142 million pace in the prior month, according to government figures released Friday. Permits, a proxy for future construction, slumped 1.7 percent to a 1.27 million rate. Both figures missed estimates.

1-unit starts fell -0.38% in March while 5+ unit (apartment) starts fell -3.44%. The Midwest was the biggest loser at -17.61%. The biggest winner was … the West at 31.40%.

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The decline in 10 year Treasury rates (yellow line) provided a nice pop in 1-unit start in January, but nada in February and Match (white line). Apartment starts (blue line) have slowed.

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So pushing interest rates down has not paid off as hoped.

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“The Sag” In The US Sovereign And Dollar Swaps Curve Continues, But Germany, UK And Japan Curves Are Sagging Too!

It’s the same all over the world.

The US Treasury actives curve and dollar swaps curves are markedly sagged (or kinked).

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But other countries are experiencing curve sags as well, but just not as pronounced. Germany, Japan, UK and France are all sagging, but less notably.

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Numerous risks abound in the global economy such as Brexit, China trade disagreement, etc.

On the other hand, there is Venezuela which has entered a seemingly permanent sag.

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And the SAG award goes to … the USA for short-term SAG.

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The permanent SAG award goes to …. Nicolas Maduro and Venezuela.

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Trump Announces Fannie And Freddie “Cap And Release” Plan

Fannie Mae and Freddie Mac’s stay in regulatory purgatory may be coming to an end.

President Trump announced his plan to recapitalize the GSEs Fannie Mae and Freddie Mac and release them into the wild.

The memorandum is short, both in length and details.

The President is directing the Secretary of the Treasury and the Secretary of Housing and Urban Development to craft administrative and legislative options for housing finance reform.

  1. Treasury will prepare a reform plan for Fannie Mae and Freddie Mac
  2. HUD will prepare a reform plan for the housing finance agencies it oversees.

What is left out of the memo is … whether Fannie and Freddie will carry a Federal guarantee or not. And where their capital will come from.

So, rather than shutting them down, Trump is “catching and releasing” like undersized lobsters. But these are not undersized (or “chicken” lobsters, but extremely large financial institutions.

For example, Fannie Mae has a loan book of 3.26 trillion …

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while Freddie Mac’s loan book is $1.93 trillion.

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This compares with Bank of America’s loan book of almost a trillion dollars.

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Wells Fargo has a similar loan book to BofA.

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So, how much capital will Fannie and Freddie have to raise to get released given their YUGE book of loans, given their interest rate exposure?

Its almost Supernatural that Fannie and Freddie are escaping purgatory.

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An Occurrence At The Federal Reserve: Increased SMART Money & Equity Volatility, Crushed Bond Volatility

Ambrose Bierce wrote a short story about a man being hanged during the American Civil War and what went through his mind in his final moments. It is called “An Occurrence At Owl Creek Bridge.” Hauntingly similar to today’s plight: overoptimistic expectations before being hung, then …. snap.

In summary., Ben Bernanke and The Federal Reserve entered the markets in 2008 in force. The Fed Funds Target rate was raised once during President Obama’s two terms as President, but eight times since President Trump’s election as President. Plus, The Fed’s Quantitative Tightening (in terms of its balance sheet) begin in earnest in 2019.

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Once The Fed hurled its monetary weight at the economy in 2008, the stock market had an amazing run. but since The Fed started to raise rates and began their balance sheet unwind, the S&P 500 index has increased in volatility as has the SMART Money Flow Index.

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The bond market volatility indices have gotten crushed by central banks.

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On the real estate front, equity REITs, like the small cap Russell equity indices, seemed to be benefit greatly from The Fed’s Zero Interest Rate Policy and QE. Mortgage REITs, on the other hand, kind of died with the financial crisis and never recovered. The RCA CPPI commercial real estate index too off like a missile.

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Like in the Ambrose Bierce short story “An Occurrence At Owl Creek Bridge,” The Fed and other central banks are quitting any attempts at rate normalization (for fear that they might hear that dreaded “snap” at the end of the monetary rope].

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Did The Federal Reserve Kill Off 10-Year Swaption Volatility? (Lowest Since 2005)

10-year Swaption volatility has sunk to the lowest level since 2005. Did The Federal Reserve provide too much liquidity for too long, effectively drowning bond volatility?

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The Fed’s lingering Target Rate near zero and its three rounds of asset purchases helped kill of bond volatiilty. And with rising Fed Target rate and balance sheet unwind (removing liquidity from markets) has pushed bond volatility to 2006-2007 levels.

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So, the answer is … YES!

(Vol has been) shot through the heart and The Fed’s to blame! The Fed gives central banks a.bad name.

Undun! S&P 500 Index Comes Undone From 10Y Treasury Yield As Term Premium Hits Low

The Treasury market has come undone (or undun as The Guess Who sang).

The S&P 500 index has come undone from the 10-year Treasury Note yield.

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Meanwhile, the 10-year term premium is at a new low, likely due to persistently low inflation.

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No sugar tonight?  Don’t worry! The probability of a Fed rate cut in 2019  is minimal.

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Alarm! Europe’s And US Bond Volatility Grinding To A Halt (Precursor To Recession)

European bond volatility (according to the Merrill Lynch 3-month EUR option volatility estimate) has plunged to the lowest level on record.

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A similar chart for the US bond market is the Merrill Lynch Option Volatility Estimate for 3-months shows exactly the same thing. The US bond market is grinding to a halt.

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Note that the US MOVE 3-month estimate hit a low in May 2007, just ahead of The Great Recession of 2007-2009.

Alarm!