Fed Hubris: Housing Prices Show the Fed is Making the Same Inflation Mistake

Mish

The Fed is repeating mistakes it made in the dotcom and housing bubble decades. A series of housing-related charts will explain.

Case-Shiller Home Price Index Levels

Case Shiller Home Price Index as of  2021-12

Here We Go Again

The Case-Shiller Home Price indexes (a measure of repeat sales of the same house) show that home prices are more extended now than ever before.

Those price levels are from December 2020.

Not Understanding Inflation

On February 10, Jerome Powell gave a speech on Getting Back to a Strong Labor Market

In his speech, Powell said the Fed "will likely aim to achieve inflation moderately above 2 percent for some time in the service of keeping inflation expectations well anchored at our 2 percent longer-run goal." 

On February 24, Powell Dissed Inflation and Ignored Questions From Congress About Leverage

On March 4,  I commented Powell Confirmed Easy Money Until the Cows Come Home.

Meaning of Stable

But why 2%, not 1% or 0%? Certainly 2% is not "stable" by any reasonable definition. 

Regardless, to make up for past inflation allegedly being lower than 2% Powell repeated his pledge to let inflation run above 2%. 

Is inflation lower than 2%? As measured by the CPI, it is. But the CPI is a terrible measure of inflation.

It ignores all asset bubbles, it ignores housing prices, and it seriously underweights medical expenses.

Medical Expenses

The CPI seriously underweights medical expenses by averaging in Medicare and Medicaid. 

Healthcare services make up 17.75% of the PPI but only 6.97% of the CPI.

Ask anyone who buys their own medical insurance how fast rates are really rising.

For discussion please see Healthcare is the Biggest PPI Component With Over 3 Times Energy's Weight

With that, let's return our spotlight to housing. 

Housing Disconnects From Rent and the CPI

CS National, Top 10 Metro as of 2020-12

Prior to 2000, home prices, Owners' Equivalent Rent (OER), and the Case Shiller national home price index all moved in sync.

This is important because home prices directly used to be in the CPI. Now they aren't. Only rent is. Yet, OER is the single largest CPI component with a hefty weight of 24.05% of the entire index. 

The BLS explains this away by calling homes a capital expense not a consumer expense. 

However, that explanation ignores easily observed and measurable inflation. And it's inflation, not alleged consumer inflation, that is important as the following charts show.

Percent Change From a Year Ago Comparison

CS National, Top 10 Metro Percent Change as of 2020-12

Year-over-year, the CPI is only up 1.4%. The OER is up 2.0%, but the Case Shiller National Home Price Index (December) is up a whopping 10.3%.

If we substitute actual home prices for OER in the CPI (as the CPI used to be calculated), the next chart shows what the CPI would look like.

I call the substitution Case-Shiller CPI (CS-CPI).

CPI, CS-CPI Year-Over-Year

CPI, CS-CPI Percent Change as of 2020-12

The BLS says the CPI is up only 1.4% from a year ago. 

However, the CS-CPI has been running between 2% and 3% for the past three years and most of the past seven years. By this measure, the Fed has already achieved its goal. 

Yet, the Fed is holding rates near zero and has pledged to remain that way.

We can calculate "Real Interest Rates" by subtracting measures of inflation from the Fed Funds Rate.

Real Interest Rates

Real Interest Rates CPI as of 2020-12

Thanks to the Fed slashing interest rates to near-zero, real interest rates are -3.45% as measured by CS-CPI but "only" -1.31% as measured by the CPI.

Third Great Fed Mistake

Brian McAuley comments This Era May Come to Be Remembered as the Federal Reserve’s Third Great Mistake

With the real interest rate at -3.45% is it any wonder speculation in stocks, junk bonds, and housing are rampant?

This is the same mistake the Fed made between 2002 and 2007 when it ignored a blooming housing bubble with dire consequences culminating in the Great Recession.

BIS Study on CPI Deflation

Note that a BIS Study finds that routine consumer price deflation is not damaging in the least.

Specifically, the BIS concludes "Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive!"

Worst of all, in their attempts to fight routine consumer price deflation, central bankers, led by the Fed, create very destructive asset bubbles that eventually collapse, setting off what they should fear – asset bubble deflations.

Mish

Comments (50)
No. 1-23
WarpartySerf
WarpartySerf

The only thing I am more sick of than hearing Trump's mouth all the time- is hearing Jay Powell tell us how concerned he is for all of our welfare.

He's the richest Fed chairman in history, $50 million and counting, and he cares less than zero about the average person. Just like the 0 % interest rates he's planning.

Go to New Zealand, will you Jerome ? And take Yellen with you. We'll fix the mess you made here much quicker without either of you in the country.

WarpartySerf
WarpartySerf

If Jay needs some relaxation, here's one fine book to read.

“They all had the politics of horse thieves. He believed in the Republic as a form of government but the Republic would have to get rid of all of that bunch of horse thieves that brought it to the pass it was in when the rebellion started.
Was there ever a people whose leaders were as truly their enemies as
this one?”

― Ernest Hemingway, For Whom the Bell Tolls

drjacobs5
drjacobs5

The low mortgage interest rates are causing insanity in the Los Angeles house market. I'm trying to buy a house but many of them are getting at least 10 offers and the winning bid is at 10%-15% above asking price. Hopefully the rising rates will help.

CoxSwane
CoxSwane

@Mish I am wondering if you have gotten any recent thoughts from Hoisington or Hunt, given recent developments. Readers would love to hear their insights, rather than wait another month for the Q1 missive.

bluestone
bluestone

"Housing disconnects from rent and CPI" is a very good statement of the separate concerns of the Fed. Its not inflation directly that they have to control, its the stink of inflation, its when it causes a problem. Its not inflation itself that forces their hand.

The trigger of the "inflation stink" is when it directly and obviously impacts the poor and their housing and consumption.

For everybody else, cheap loans in a rising markets hey music playing lets dance. So they can "look through" temporary spikes as long as the "temporary spikes" don't stink.
That aside, it looks as though we are still post 2008 on the Von Mises cusp of either taking the pain and dealing with the debt or debasing the currency. Who knew it could go on so long..

bradw2k
bradw2k

FOMC must run purely on hope now, that the market monster can go one more year without throwing a tantrum.

PecuniaNonOlet
PecuniaNonOlet

What’s the story with evictions? Free money, free rent, raising housing prices. It is more bizzare than Alice in Wonderland.

njbr
njbr

Well it's a brave new world all around.

Glenn Greenwald says Trump, Bannon and Tucker Carlson are the true socialists...“I would describe a lot of people on the right as being socialist. I would consider Steve Bannon to be socialist. I would consider the 2016 iteration of Donald Trump the candidate to be a socialist, based on what he was saying. I would consider Tucker Carlson to be a socialist.”

Whooda thunkit...the GOP knows even less.

Jackula
Jackula

I've been wondering what real interest rates are currently, thanks Mish for the informative post. Everybody thinks inflation is coming so we are seeing a late 70's style event, buy hard assets, especially real estate since rates are starting to rise, as fast as you can. This is not going to end well and Powell is no Volker. Next up operation twist.

rhcaldwell
rhcaldwell

I think it’s fair to say the Fed system is a failed model. Yes, we need a central bank. No, it should not be captured for and by the finance industry.

Sechel
Sechel

This post could be about any time. The Fed's measure of inflation has always been an issue. What has changed? Seems like this is an old issue and not a new one.

WarpartySerf
WarpartySerf

I've got the story for Mish (re "I don't read much except about finance")
It's "A Deal In Wheat" by Frank Norris ... all about two Chicago wheat traders, as they decimate the common man ..... The conclusion:

"He had seen the two ends of a great wheat operation- a battle between Bear and Bull. .... The farmer- he who raised the wheat- was ruined upon one hand- the working man- he who consumed it- was ruined upon the other- But between the two, the great operators, who never saw the wheat they traded in, bought and sold the world's food, gambled in the nourishment of entire nations, practised their tricks, their chicanery and obliquely shifty "deals", were reconciled in their differences, and went on through their appointed way, jovial, contented, enthroned, and unassailable."

KidHorn
KidHorn

Seems the inflation is concentrated in suburban homes. Not inner city homes. People are fleeing the insane inner city governments.

WarpartySerf
WarpartySerf

Mish I found a link to that great short story ..... you don't have to even trek to the library !

Eddie_T
Eddie_T

OT: The dollar topped at 92.19 after showing real strength yesterday.

It looks ready to ease off now....which is what I expected...gold is trying to bounce off support. 1700 got breached slightly yesterday, but the 1690-1700 level seems to be the new support.

The 10 Yr Treasury Bond spiked al the way up to 1.614, but is now also easing. This sets gold up for a bounce, but it’s tepid so far

GaiaMoney
GaiaMoney

Talking of Fed mistakes, Mish, what do you think of Karen Petrou's "Engine of Inequality: The Fed and the Future of Wealth in America" ?
 

1 Reply

Roadrunner12
Roadrunner12

"First, the Fed must understand that the way it judges employment, price stability, and prosperity relies on aggregates and averages that obscure the reality for most American families. Relying on different data may seem like a pedestrian solution, but bad data means bad policy with unintended consequences. The Fed doesn’t want to make America less equal, but it did so in part because it mistook the mean for the median. The reason that the Fed can’t quickly raise rates or reduce its huge portfolio underscores why it should: financial markets are now so dependent on the Fed — rather than economic fundamentals — that any monetary-policy change badly rattles the financial system. Forward guidance needs to alert financial markets to a gradual, measured shift to a more normal system in which the Federal Reserve supports the market instead of being the market."

Absolutely agree that the Fed cant quickly raise rates or reduce its portfolio underscores why it should. The Fed cant see that its policies are hollowing out the middle class and driving inequality. The rich are getting richer and the poor are getting poorer.

Eddie_T
Eddie_T

Another inflation anecdote.

I just sat down with a very young banker to open an account to dispense my PPP-2 funds...I like to keep these bail-outs in dedicated accounts for tracking. He related that he and his wife are closing on their first house, out in the burb where I practice.

They had to pay $100K over the asking price (of $325K) to secure their first home. I was blown away. I do feel for these kids trying to service that kind of debt....but I know that over time that the mortgage leverage and the amortization leverage will still allow them to build a lot of wealth, so I think they are making a wise decision.

People don’t buy houses because houses are a good deal They buy houses to raise a family. Life goes on.

I feel about a half-million richer than I did at breakfast..

Doug78
Doug78

Recipe for a Booming House Market:

Take
2.73%, for 30 year fixed rate from Freddie Mac
Add:
Housing inventories down 23% to a record low
Add:
Pandemic that keeps most people working but not spending

Put in oven for 9 months

Take out of oven and pour 2 trillion Dollars over it
Do not let cool and eat it hot

Eddie_T
Eddie_T

I have one rental unit at the lake, on my boat storage property, It just got vacated. It’s the only house I personally manage, because my management company in Austin won’t touch anything that far out of town.

Got to take the dogs and drive out this morning for the walk-through. Nice spring day here. Nothing to remind me of the great storm except for a lot of dead plants in my yard that will take years to replace or nurture back to health.

I already got a call from somebody wanting to rent it. At the lake, the grapevine news does my advertising for me. lol.

Farce Majeur
Farce Majeur

You can keep them, we have their puppets Adrian Orr and Grant Robertson doing the Fed’s bidding precisely as instructed. Our houses are up over 20% for the year, median approaching 900k (650k usd), with median income around 50k. Criminal!

Betweentwoages
Betweentwoages

The funny thing is those who don't realize the Market needs constant intervention not to implode.

The Fed's real mistake (when you understand the dire circumstance of that former point) is rising bond yields world wide and the rate at which they are climbing and how quickly they can unwind equity markets that are levered long. Powell says rising rates are a sign of confidence (market takes this as please lever up on tsunami of liquidity and short long bonds to the moon ...i will be sitting on my hands) Get the heck out of equities until this blows over. Fed is going to need to intervene ...first they need to say they stand ready to keep borrowing costs accommodating to facilitate more traction on recovery...see market response and adjust accordingly...the ECB will move in lockstep and they can achieve a further kicking of the can...which allows governments to run large deficits...and bond yields to stay depressed so asset values keep households solvent. IF you have not realized we crossed the Rubicon many moons ago with regard to letting the market "sort it out" then you are not doing anyone a service by giving them advice. There can never be normalization without a global reset of capitalism and one is coming ....it's just whether we want to kick the can for a while longer....that world is preferred.

Betweentwoages
Betweentwoages

The market is dependent on intervention. Folks may absolutely HATE that fact but we crossed the Rubicon well over a decade ago. Monetary systems have a shelf life...this one is long in the tooth and the patient's life is now dependent on this intervention ...the patients life being household balance sheets, Pension system solvency...you know national security issues. IF you hate this so much that you don't want to see the NEED of continued intervention then you are really brilliant. I find when i bury my head in the sand...great things usually happen.

The fed has built a mountain of asset appreciation on intervention....record low rates...gigantic balance sheet growth and now they have a massively levered up market ...and interest rates (bond yields ) climbing quickly. One could argue Powell testimony over the last couple weeks has actually encouraged the monster liquidity in this market to gather in to SHORT long bonds. Investors love to Front run the fed, and they are hesitant to fight the fed. So Powell....(either trying to let froth out of market) or not quite getting this....says to market ...why don't you take all that leverage and short the long bond....i am going to sit on my hands for a while...no worries. So ...the market..always searching for Alpha sends a tidal wave of TLT shorts to make some low risk alpha returns. Powell and the ECB seem to want to act in sink and it will be entertaining to watch the continued shorting of Long bond yields chaotically attack the equity markets until they make Powell eat his words....and it seems like he won't act forcibly enough to make a difference. I just wonder at what level the shorts are looking for in the 10 year....2.0% they will push it by the end of April if not sooner.

What is the SPX equivalent for a 10 year that Powell encourages shorts to push to 2% in search for alpha as he promises to sit on his hands....

Superbadbubble
Superbadbubble

I personally can't wait for the catastrophic failure of residential real estate. I am in all cash right now and hope to pick up many homes, when thos that have way overpaid can't keep overpaying. Wringing my hands now and salivating. Prices Up 20% in my state in just one year. Tje.most ever! I love when people have memory loss. ie what happened in 2009? I forget. Last time at bottom of bubble I made bank now at top of bubble I made bank. COME ON BUBBLE BREAK BREAK


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