Fed Meetings and Asset Prices

March 17, 2014
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Fed Meetings and Asset Prices

The FOMC meets this week, and most expect them to continue to taper their purchases of longer term MBS and Treasuries at a slow pace. Of course, there could be a surprise around the corner. If there is a surprise, what assets are likely to be affected? And why?

The second question is challenging–it has been the focus of a lot of research. We certainly aren’t going to be able to answer it in a single blog post! But we’ll take a stab at the first, and leave the second for future posts.

Our approach is to look at single-day asset returns for two dates in 2013 on which FOMC announcements had a major impact on asset prices: 06/19/2013, or the “taper tantrum,” and 09/18/2013, or the “taper headfake”. As a quick review, the taper tantrum in June was when the Fed announced that they wanted to begin the conversation of tapering QE purchases of long-term government bonds and mortgage-backed securities. The taper headfake in September was when they unexpectedly decided to hold off on tapering. A look at hourly movements in asset prices on these days reveals definitive evidence that the market was reacting to the FOMC announcement and . . .

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Household Debt and the Great Depression

March 15, 2014
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In November 1930, before anyone knew how Great the Depression would be, Charles Persons published an article in the Quarterly Journal of Economics called “Credit Expansion, 1920 to 1929, and Its Lessons.” His thesis was stated forcefully in the first paragraph:

“The thesis of this paper is that the existing depression was due essentially to the great wave of credit expansion in the past decade.”

He then meticulously documented data on the stunning growth in borrowing by households during the 1920s. As is common in the run-up to severe economic downturns, there was a tremendous growth in mortgage debt. “The great field of credit expansion in the last decade lies in the realm of urban real estate mortgages”, Persons wrote. In nominal terms, outstanding mortgage debt grew by more than eight times from 1920 to 1929, according to Persons.

Persons also highlighted the rise in installment debt, or consumer debt used to purchase new furniture, clothing, sewing machines, and cars. Martha Olney at Berkeley examined the rise in purchases of cars and other durables during the 1920s, and concluded that “societal attitudes toward borrowers changed radically between 1900 and 1920; by the mid-1920s, buying on credit was considered normal, not . . .

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Investors Pulling Back — What Happens to Housing Now?

March 14, 2014
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Bill McBride at calculatedriskblog.com (a must read in the economics blogosphere) has been doing some fantastic posts on the abrupt pull-back by investors in the U.S. housing market. They were very aggressively buying homes in depressed markets from 2010 to 2012, but the excitement is now cooling. This is closely related to a previous post where we showed that house price growth has been stronger in cities where investors were extremely active.

See this, this, and this.

We argued in our previous post that the 2010-2013 housing rebound was “strange” because it was driven mostly by investors buying up foreclosed properties that were sold at prices below fundamental value (a “fire sale”, in the language of Shleifer and Vishny).

What happens now that these investors no longer see bargains? Who steps in to buy? Is the 2010-2013 pace of house price growth sustainable? Difficult questions. We plan on looking deeper at this issue as more data become available.

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China and the Dangers of Debt

March 13, 2014
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China and the Dangers of Debt

News this morning shows that industrial output growth in China reached a 5-year low. What lies ahead for the Chinese economy?

China’s economic growth over the last 15 years has been spectacular. But there is one aspect of Chinese growth more recently that merits concern: its increasing reliance on debt. Consider the graph below that plots China’s annual GDP per capita growth rate from 1997 onwards. China grew at a very healthy rate of 7 to 8 percent between 1997 and 2003.

During the same period its domestic private debt–debt owed by Chinese individuals and businesses–grew at a much faster rate, with the private debt to GDP ratio going from about 100% of GDP in 1997 to 125% of GDP in 2003 (see the solid line in figure below). The increasing reliance on debt for growth is a consequence of China’s ultra-low domestic consumption. The excess savings of China’s state, household, and corporate sectors are channeled into the state-owned banking sector which loans it out to finance domestic investment. This is all fine, except that a country’s private debt to GDP ratio cannot rise forever – something eventually has to give.

China got a break starting 2003. It no . . .

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Weakening Economy or Just Bad Winter?

March 12, 2014
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Weakening Economy or Just Bad Winter?

Retail spending by households in January 2014 was a major disappointment, coming in well below expectations. January 2014 was also one of the coldest months in memory in many parts of the country. Was the extreme cold weather to blame for weak retail spending? Or is the economy weakening? These questions are especially pressing given the release of data tomorrow on February 2014 retail spending–February again was a very cold month.

We use state-level data on new auto purchases to attack this question. Here is the basic idea. Not all states experienced a horrible January 2014 — in fact, much of the western part of the country actually was warmer than normal. We can use this variation across the country in January weather to see if national auto sales were brought down by states that experienced abnormally cold temperatures.

First, let’s split up states into five categories based on how far below their normal January temperature they were in January 2014. And then let’s look at the average growth in year-over-year new auto purchases in each of the groups. Here is the chart:

The evidence is pretty clear. New auto purchases in January 2014 were . . .

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Emerging Market Nightmare?

March 11, 2014
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Emerging Market Nightmare?

Hyun Song Shin (@HyunSongShin) of Princeton University (Atif’s colleague at the Bendheim Center for Finance) has been doing some terrific work on a potential emerging market crisis. His big worry is the rise in non-financial corporate debt in emerging markets, and the important role that bond managers have played in buying up this debt.

One of the points Shin makes is that a lot of this debt has been raised by emerging market multi-nationals outside of their home country – thus bypassing their local regulatory authorities. It is a kind of carry trade done by the big boys of emerging markets: keep deposits at home to earn higher yield on corporate deposits in local currency, and borrow in dollars at very low rates in London or Hong Kong. Of course doing so exposes the corporations (and their economies) to exchange rate risk. This is an old story – remember the East Asian crisis?

Here is the scary chart:

Shin offers a scenario in which elevated levels of emerging market debt could lead to serious problems. It goes as follows. A monetary tightening in the U.S. or Europe leads to:

A rise . . .

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How Bad Has the Winter Been?

March 10, 2014
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How Bad Has the Winter Been?

February retail sales are out Thursday. The debate has been raging on whether weak spending this winter can be blamed on the brutal weather. We may have some thoughts on this precise question in a post later this week. But for now, given that one of us lives in Chiberia, we thought we would show just how bad this winter has been.

Using average minimum temperature as a measure, this is the second worst winter in Chicago since the data began in 1958. Only the winter of 1962-1963 was worse. Yes, the weather today in Chicago is absolutely beautiful. Let’s hope it stays that way!

You can also see global warming in this chart. Just check out how many of the post 2000 years are on the right side versus left side of the chart.

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Housing Market Rebound Fundamentally Different

March 10, 2014
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Our initial blog post on Friday made the argument that the housing market rebound was driven primarily by investors buying up foreclosed properties. As a result, we should not expect it to fuel household spending as we saw before.

Two articles out today make arguments that are closely related: home building is shifting toward rental apartments and surging home prices are pricing out first-time buyers.

New Home Building Is Shifting to Apartments, by Conor Dougherty (@ConorDougherty)

Surging Home Prices Are a Double-Edged Sword, by Nick Timiraos (@NickTimiraos)

Both of these excellent reporters are must follows if you want to understand developments in the housing market.

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The Federal Reserve and Wealth Inequality

March 9, 2014
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The Federal Reserve and Wealth Inequality

The Federal Reserve has a well-defined dual-mandate: stabilize prices and maximize employment. However, in trying to achieve these objectives, the Fed can inadvertently favor some segments of the population more than others. This was indeed the case from the perspective of households’ net worth position during the Great Recession.

We have already highlighted the highly unequal distribution of financial wealth in the United States in a previous post. One way to think about wealth inequality is that there are two kinds of homeowners. Those at the very top end of the wealth distribution who own most of the stocks and bonds in the economy – let’s call them creditors. And for the rest the single biggest asset is their home – let’s call them debtors. The debtors do not own much wealth outside of their homes, and in fact need to take out a mortgage from the creditors to purchase the house. Of course, the financial system intermediates this process, but ultimately creditors are lending to debtors.

When the economy slows down and there is a sharp decline in house prices, it is debtors who initially suffer. It is the debtors’ net worth that is most heavily impacted, . . .

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The Great Housing Hangover

March 8, 2014
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The Great Housing Hangover

Just how bad was the housing binge from 2002 to 2006? Here is retail spending on furniture, appliances, and home improvement from 2006 to 2013. The lines are indexed to 2006, so for every year, if you take the point for that year and subtract 100 you get the percentage change from 2006 to that year.

It is stunning. Nominal retail spending on furniture, appliances, and home improvement remains below its 2006 level in 2013, 7 full years later. Remember that this is nominal spending, so if you adjust for inflation the gap is even larger!

A natural question is whether 2006 represents a useful benchmark. Perhaps spending on housing-related goods in 2006 was artificially inflated by the housing boom, and is therefore not a useful reference point? Or alternatively, perhaps 2006 spending was what we would expect from a normally functioning economy?

The truth is in between. Spending on housing-related goods was no doubt fueled by the unsustainable housing boom. But the correction is likely also too extreme — different policy actions during the Great Recession likely could have helped soften the blow.

What policies? You will have to wait until our book comes out in . . .

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