April Trade Deficit, MEW and Interest Rates
Submitted by
CalculatedRisk on Fri, 06/08/2007 - 7:59am (42 comments)
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I couldn't have said it better myself.
thank you-CR
Very nice explanation. It's amazing how much you can pick up when the people providing the info are clear and willing to state the reasons for their beliefs.
Off topic, but I wanted to make sure you saw this:
Townhomes a steal in Fort Myers |
WINK News - News, Sports and Weather
- Southwest Florida
| Local & Florida
New townhomes in Fla. auctioned for 1/2 what the builder was selling units for that closed as recently as December 06. It's getting very ugly in Florida.
FTR, I picked that up at the NJrereport.com who picked it up from Ben Jones (thehousingbubbleblog.com for those who might be new).
Yep. BB really doesn't have the capacity to alter the overall course. The trade and current account deficits are in such a deep hole he's pretty much been rendered insignificant. In a corner 1000 ways. His presecessors had the benefit of being the only elephant. BB is the elephant in a herd with a lot of other elephants that can do what they want.
Sitting on variable rate debt doesn't look as attractive as the chief cheerleader for the products, AG, led everyone to believe. I wonder if he has any regrets? Gonna be a lot of grief to go around and he's largely responsible.
CR, the negative spiral of lower trade deficit/less foreign CB investment leading to less MEW and rising rates I can see. However, do you have any macro predictions on how this going to have an effect on the foreign CB's current plans to diversify? I can see a very nasty interest rate spike if the flow of money they have to invest becomes even less or turns net negative (less trade proceeds minus greater cash flows to out of US investments or even just out of US treasuries). Put in a falling dollar and falling housing equity values due to higher interest rates and I could see this become a very nasty negatively reinforcing cycle indeed.
an old saying that banks only lend money to folks that don't need it.
If you have lost your job and have a high debt overhead (mortgage, cars, CC)then the banks may decline to assist you or add a significant premium to the interest rate for the added risk.
As the American economy declines combined with our high debt levels foreign investors may not find us an attractive investment unless the risk premium is higher.
well stated I thought. Dennis Gartman also voiced similar comments some time back.
This could lead to a vicious cycle for a short time - less MEW leading to a lower trade deficit, followed by rising rates, follow by less MEW, and repeat.
What would stop the Fed from stepping into the bond market and buying treasuries to lower rates in this situation?
My understanding is that they've done this before to defend their interest rate targets.
Why would this scenario be different if it was creating serious economic problems? (Assuming Wall Street doesn't still have them in a corner with their wild money printing spree.)
CR,
Great post -- and great call on rates.
The decline in the trade deficit is part of the U.S. economy's overall adjustment towards a higher savings rate. Part of the adjustment involves having higher real rates which reward domestic savings, and part is a decline in consumer credit (including mortgages). The question is how does the currency behave during this adjustment? Deflationists say the dollar will strengthen as debtors seek dollars with which to repay debt (I'm frankly a little murky on how this works). Inflationists believe the Fed will fight real rates tooth and nail (they have no choice given the level of leverage), and the dollar will suffer accordingly.
I'm in the second camp, and I believe most of the adjustment will come not from real rates but from a decline in borrowing brought about by mortgage and credit card defaults. The eventual solution as per Ben Bernanke is the same one he thinks the 1930's Fed should have employed: do not allow deflation to take hold, and simply provide as much liquidity as is necessary to prevent it.
Very lucid and well-laid out thesis. I'm wondering what the impact of US funds being invested abroad would be? In other words, the vicious cycle would depend on the current account deficit, no?
When total US funds flowing to other nations declines, then there is less money to invest in treasuries. In a pinch, money that is being allocated to private equity and public equity by the Sovereign Funds could be re-directed to treasuries.
My point is that only when the current account balance begins to decline in a meaningful way, will the vicious circle start. The current events, in my opinion, are just the "crank" slipping a ratchet.
Keep up the great work!
gmak.
Increasingly the TIC report is going to be vital to confirm this thesis.
I'd want to see trade deficit ex-oil ex-autos.
My guess is that the effect comes from something like the following:
Declining interest rates outside of the increase the demand for US long bonds and strengthen the dollar.
Low long bond yeilds encourage morgage equity withdrawals and a stronger dollar encourages imports.
Check out: PACIFIC Exchange Rate Service
When the Yen is falling the ex-oil trade deficit is accelerating. When the Yen is rising the deficit flattens out.
I think BB can only ease by holding rates steady in an inflationary enviornment, the golden age of excesssively low interest rates is over.
Bad news if you bought a house after 2003 have ARM, good if you got a 30 year fixed or you can pay cash for your house.
CR, what sort of correlation coefficient do you get between MEW and the trade balance?
Yep, I agree. Our economy is transitioning to one that is more saving and export based, simply because we have a lot we owe, and you gotta pay the chits sometime.
The question is, are we going to have a relatively smooth transition, or a painful one? It's not binary. I think that even a mild recession is consistent with a smooth transition.
Let's face it, you could have a downturn that's relatively isolated, and the agrregate numbers would move from growth to recession, even if everybody outside the hurting sectors are trucking along as before.
Looks like Plunge Protection Team is at it today.
Love that wonky MEW line. Does everyone pay for Christmas and new cars in the fall with their MEW?
A $64,000 question is if the growth in the rest of the world continues. I can easily find examples of a few countries even more vulnerable than US (Spain, Ireland). Moreover, the credit bubble is absolutely omnipresent. There are bubbles almost everywhere you look. When the cheap money ends, these bubbles should pop.
From Winknews.com:
Town homes a steal in Fort Myers
By WINK News
Fort Myers - You're not going to believe what some brand new townhomes went for on the auction block Thursday
night in Fort Myers, considering where prices have been. A three bedroom townhome previously priced at
$310,000 sold for about $180,000! First time home buyer Brandon Quarterman, a student at Florida Gulf Coast
University, was the lucky bidder. He said, 'I'm feeling great. more money in my pocket!"
The two and three bedroom townhouses in the San Simeon development, which is off of Winkler Avenue, were
selling for prices we haven't seen in Southwest Florida in quite some time. And that was the whole point.
Marketing reps with the developer, Levitt and Sons, say they're trying to quickly unload the fifty homes. Most
of them were left over after people and investors backed out of deals when the housing market changed. Levitt
and Son's Jama Shaw said, "This is our aggressive approach in moving onto our next phases and new floor
plans."
Greg Toher was outraged when he heard the prices some of the homes were going for. Walking out of the auction
room, he told us, "$145,000! Unbelievable! We paid $300,000! They just got rid of at least four for $145,000!"
He says he closed on his three bedroom San Simeon townhome in December, "You've got to be kidding me, that's
not fair."
New buyers may be getting a steal, but current San Simeon homeowners, like Greg, tell WINK News they feel like
they've been ripped off. Tara Gionpalo said, "I feel really mad, really sad, hurt."
Victoria Toher said the developer went back on their word, "They promised us they were not going to go below
market value." A Levitt and Sons representative told WINK News on Thursday night that the homes did go for
fair market value...as determined by the hundreds of bidders at the auction. He went on to say they feel
terrible for the homeowners, but the prices were reflective of a challenging real estate market and they're
confident it will once again shift in the homeowner's favor.
Bruce Sexton, another San Simeon homeowner who closed on his house in October is not convinced, "I don't think
they have loyalty to the people who purchased early. They're just trying to dump the houses and get what they
can."
June 7 (Bloomberg) -- Ohio, the state with the third highest number of foreclosures, sued 10 real estate companies for improperly pressuring appraisers to inflate home values.
The companies, based in Ohio, California, Arizona and New York, are accused of setting specific estimated values on properties and communicating a desired price to appraisers, according to the lawsuits filed by Attorney General Marc Dann today. In Ohio, it's illegal to influence an appraiser. Those sued include seven mortgage brokers, two lenders and an appraiser.
Foreclosure filings in Ohio jumped 135 percent in April from a year ago, pushing the state's rate to almost twice the national average, according to RealtyTrac Inc. States have opened investigations of mortgage brokers, lenders and appraisers as delinquencies rise across the U.S., led by subprime borrowers.
It's a step in the right direction,'' said Jonathan Miller, a New York-based appraiser for two decades who says appraisers often face pressure from brokers and lenders.Finally someone is listening.'
Good stuff as usual. In addition to shrinking MEW I would mention debt obligation increases as a second potential factor that could reduce the deficit and cause further rate increases.
Nevertheless, Brad Setser says that US's net interest payments will increase sharply, and if that money comes back to treasuries, rate hikes could not occur.
A reduction in MEW is a negative for consumer spending, foreign purchases and U.S. & global growth. Why should a MEW reduction lead to an increase in rates? Maybe it does in the short-term, but in the intermediate-to-long term, I think it leads to lower interest rates.
The "vendor financing" being done by China only works if the customer keeps buying. When the customer reduces his/her consumption, the vendor doesn't need to produce as much stuff -- ergo, lower production and lower global growth.
From Housing Wire Blog:
National Mortgage News is reporting this morning that Capital One lending unit GreenPoint laid off a significant chunk of its workforce today amid continuing problems in the Alt-A lending market:
Subprime mortgage concerns that have tightened underwriting standards and diminished secondary market appetite in the neighboring near prime market have forced originator GreenPoint here to cut 440 staff positions and close 12 of its 41 operational centers, according to a company spokesperson.
Im actually surprised by this, as I thought Alt-A had nominally recovered from its short slump. Apparently not.
Bond investor, I think CR is suggesting that the US Treasury yields will be higher partly because they will need to sweeten the pot to generate demand and cash flow, to keep the US economy moving.
More sunny optimism from Comstock Partners: Inflation fears are preventing the Fed from taking any action to save the economy from a hard landing or recession until it is too late, they write in weekly commentary. As we have stated previously, the Fed is paralyzed between rising inflation on the one hand and a deteriorating economy on the other, and is therefore doing nothing.
I would agree with this assessment except that I would specify "financial asset inflation" fears.
BTW the Fed concluded that Japan failed to cut rates soon enough when their bubbles burst. Easier said than done, isn't it?
Euro down. S&P up.
Great day for US equity investors. About 2% total gain.
Except that it doesn't make sense. Fewer dollars chasing the Euro. More dollars chasing the S&P.
People bailing out of the Euro to invest in American stocks.
And these are guys who want to be long over the weekend, when planes on the decks of carriers across the Persian Gulf are fueling right now for the night bombing run.
Higher interest rates don't fit the logic of the bearish position. (Not the first time the bears' own argument doesn't hold up to its own internal logic.)
If lending standards have tightened forcing some borrowers out of the market, and housing is "too expensive" forcing other borrowers out of the market, and year-over-year housing sales are "disastrous" and there actually are fewer borrowers, that means there are fewer borrowers, right?
Fewer borrowers means less demand for credit. Less demand for credit means lower "price" for money, i.e., lower interest rates.
With all the focus on the jump in 10-year rates, the bears have forgotten completely about short-term rates, which have been falling for months.
http://finance.yahoo.com/charts#chart2:symbol=^irx;range=6m;indicator=volume;charttype=line;crosshair=on;logscale=off;source=undefined
Since ARM's are set by short-term rates and not by long-term rates, the whole idea that the rise in 10-year yields is somehow "bad" for housing is...not precisely on-point, is it?
Sebastia
Sebastian,
ARM share of the Mortgage applications has been dropping.. the whole point is the people out shopping know to go fixed. More demand for fixed, much less demand for short term ARMs..
Also the treasuries are influenced but in no way defined by the mortgage market, what you are seeing now is people betting on the short end of the yield curve and not going long.
Sebastian,
I think the price rise was not in the face of a decreasing DEMAND, but a decreasing SUPPLY of money to be lent at these rates. A decrease in supply also leads to a price rise, no?
In addition,
Homeowners in trouble at this point are mostly those who paid too much for a house no matter the rates. The current forclosures are early payment defaults, those who arent paying even on their rediculously low intro rates, as well as those who need to refi (into an ARM or whatever) and can't get a loan since the loan amount is more that the value of the house, and finally those who need to sell (divorce, move, jobloss) and can't. It's not a problem low short term rates can help with.
Sebastian, Have we seen the bottom in housing - existing or new? Maybe is not an acceptable response. If not, are you going to join Paulson in calling it?
My prediction is Q3 '08 for new construction (marked by sales increases) and sometime in 2010 for existing (when prices stop declining). We should see an uptick in sales for existing once REOs with a lot of price flexibility come online towards the end of this year. The NAR will revise their price drop targets monthly all year to show a national decline of ~5% by Dec.
Sebastian, I described last year how the U.S. economy could slow, led by a slowdown in housing, and that could lead to a lower trade deficit and higher interest rates - for a short period. Right or wrong, it's definitely possible.
As Bond investor, notes, in the intermediate to long period, a U.S. slowdown would lead to lower rates - but I'm talking short term (this year, maybe next).
A good test: are interest rates rising even with inflation expectations steady? The answer appears yes. See: Dr. Altig's post today What is going on? As Stuart notes, the TIC report is going to be very interesting.
Best to all.
Homeowners in trouble at this point are mostly those who paid too much for a house no matter the rates.
Lets not forget the refi gang the proud owners of large 1st loans (consoldidation loans) that have little or no connection to the value of the home today.
As home prices decline more and more citizens become upside down on the mortgage.
Prime has been fixed at 8.25% for about a year now, and 3 month libor has been 5.36% +/- 7 bps over the same period. Since these are the benchmarks for short-term lending, I'm curious to know which short-term rates have been falling for months? I'm sorry but anyone who tries to make the argument that a 75 bps increase in the benchmark 10 year rate over the past two months will have no impact on a housing market where debt service ratios and affordability are major problems can only be described as reality challenged.
Margin calls anyone?
The company provided little detail on the derivatives contracts, which are linked to the European interbank offered rate, or Euribor. While customers typically use the derivatives to hedge against interest-rate swings, some may have been betting on future interest rates, Milan-based brokerage Euromobiliare said in a note last week.
The contracts have so-called ``leverage and barrier elements,'' which are contributing to widening losses, Italease said, without giving further details.
Clients holding derivatives with a barrier'' may have lost protection from rising interest rates after borrowing costs reached a predetermined level, said John Raymond, an analyst with Creditsights Inc. in London. Theleverage'' element of the contract may have added to clients' liabilities as interest rates rose above the predetermined barrier, he said.
Goldman, Mediobanca May Take Italease Stake as Losses Mount - Bloomberg.com
I'm sorry but anyone who tries to make the argument that a 75 bps increase in the benchmark 10 year rate over the past two months will have no impact on a housing market where debt service ratios and affordability are major problems can only be described as reality challenged.
Nahhh... Sebastian's just wearing his Kudlow-colored glasses.
I am seeing a decline in the $ available for mortgages,actual underwriting!(not where it should be,but genuine underwriting!!!) being done,and a lot of folks who are SOL when it comes to refinancing their ARM.The big reasons for not being able to refi are NO equity,the shocking requirement to document income and debt to income ratios worthy of a hapsburg prince.My shop is going under,so i'll find somewhere else to hang my license.too bad,it was a clean little shop.
Sebastian
"Since ARM's are set by short-term rates and not by long-term rates, the whole idea that the rise in 10-year yields is somehow "bad" for housing is...not precisely on-point, is it?:)"
So let me get this straight, your saying that after all the media coverage about people getting screwed with ARMs that a new bunch of fools are again going to line up in droves to jump on that hand grenade again. I dont buy it and I ran it by my dog and he doesnt either.
As Stuart notes, the TIC report is going to be very interesting.
Yup.
That and how aggressively the PBoC fights the USD decline against the RMB. The peg after all is de facto and only maintained by near constant PBoC intervention buying USD denominated 'assets' (then sterilizing them)...
And since there is no law stating they have to buy treasuries or any debt instruments (agencies or what have you)... it is possible they could buy equities instead & forgo treasuries/agency.
Currency exchange rate result is the same but could still lead to a vicious cycle even though CA balance hardly budges.
This story has more curves, bends and diversions than a Mississippi backwater.
ReadingNLearning,
I thought Alt-A had nominally recovered from its short slump.
I suggest you have a good look at The Chart (The Credit Suisse monthly reset chart, there are references to it everywhere). Given the quantity of 2/28 or 3/27 Alt-A issued in 2005/06, many theorize the pain will go on and on ...
First I have to say that the trade number really surprised me, particularly the oil componenet when oil prices have been going up and we are importing an increasing share of gasoline as opposed to just crude. I would not be at all surprised to see the deficit revised upwards for the month. However I do think the long term trend in the dollar is down, and it is the only thing that will seriously bring the deficit under control. The stabilization of and nacient tune in the deficit is probably as much due to the move we have already seen in the dollar vs. the euro. The initial decline in the dollar actually produces an increase in the deficit, and only with a fairly sginficant lag does it cause a reduction (the J curve effect). A reduction in the defict leads directly to an increase in GDP growth ((C+I+G+(X-M))= GDP. Trade is probably the principal reason the U.S. avoids a recession, and only suffers anemic but positive growth this year and into 08.