On a seemingly quiet news and market day just before the New Year's Holiday, the key news item of December 29th, the Case-Shiller Home Prices index, drew little attention.
However, commentary suggests that the data (for October) implies that demand, though only in line with expectations, was pushed forward by government tax credits and is likely to fade when these expire in mid 2010, unless of course it is extended yet again. The options are not tempting:
· If the credit expires, housing demand is likely to drop off, especially because much of the prior purchases were simply pushed forward to exploit the temporary tax credit, robbing the market of future demand. Ramifications for jobs, spending would be negative.
· However, if the credit is extended, that would be a form of stimulus spending which would pound the already weak USD, which in turn could start a nasty downward spiral and double-dip/ 'W" shaped "recovery" as it means:
1. Rising Long Term Treasury Yields: A weakening dollar hurts US Treasury bond demand and thus forces rising long term rates needed to peddle the stuff. We're already seeing this happen.
2. Rising Mortgage Rates: That, in turn, would drive up new mortgage rates. Worse, it would mean that the waves of Adjustable Rate Mortgages due to reset higher in 2010-2011.
3. Rising Default Rates and Declining Real Estate Prices: Mortgage reset rates, already set to rise, would become that much higher, bringing that many more defaults and troubles for the critical banking and housing, sectors. Note that current studies suggest the vast majority of mortgage holders, particularly those with mortgages under 15 years old, have zero or negative equity in their homes due to declining house prices. Add to this witches brew continued job losses or even just wage stagnation combined with rising mortgage costs, and we get higher default rates, both residential and commercial, as both forced and "strategic" defaults grow (see Jingle Mail Rock: Strategic Mortgage Defaults Could Increase Dramatically in 2010 for more on this).
4. Renewed Housing and Banking Sector Crisis: Rising default rates, already rising, further weaken the already troubled banking and housing sector with asset write downs and further declines in property values as more inventory hits an oversaturated market. Remember, the housing and banking sectors lead us into the crisis, into the current rally, and are essential for any sustained recovery.
5. The Feared "Double Dip Recession": Further downturns in these sectors would thus likely send stock and other risk asset markets tumbling. Unless there are more bailouts, which in turn hits the USD again…? (Go to item 1 above and repeat).
The other key upshot was the observation in Parsing the Latest Data from S&P/Case-Shiller that the prior housing decline in the 90s lasted about 8 years, and that was against a better economic background filled with the rise of growth fueling technologies like cell phones and the internet. The current housing mess is only a bit over 2 years old, and is against the backdrop of a weaker, more debt laden government and economy. This suggests the housing market, and thus the banks, and thus the economy, is likely to be struggling for years to come.
Hope I'm wrong on this, and the above is far from certain. If nothing else, deeper troubles in the EU and elsewhere could keep up demand for the USD and thus US debt as the USD wins this contest of the least ugly. In forex, all is relative, and the least ugly currency wins just as well as the prettiest one.