Per-Capita Adjusted Retail Sales: Not Such a Bright Picture
Earlier today Calculated Risk posted about an improvement in total retail sales. I was interested in how these numbers would look once adjusted to their per-capita numbers. Obviously the population estimates (from the Census Bureau) might have a little bit of an error margin, but I wanted to see how the spending trends of Americans had, or had not, changed. In essence, I wanted to know if people were really spending more, or if the growth in total sales was just a by-product of population growth.
This doesn’t say much about the retail sector, because it isn’t adjusted to account for store openings and closings, in other words, as stores close and sales keep steady, revenue per store is increasing, but it does give us some clues as to whether there is upcoming expansion in the retail sector as the recovery takes hold. From what I gather from these graphs, I’d say an expansion in the number retail outlets is not something we should be expecting any time soon, which is bad news for REITs that operate shopping centers.
There is no adjustments for price levels, because of auto-correlation. Please feel free to submit questions, comments, or sector-specific requests.
I look forward to, in the future, making all my data sources available so they can be reviewed by anyone who may have any doubts about my methods. Just hold on a bit for that.
Mortgage Rates, Purchasing Power and Home Prices
As you may have seen, the Case-Shiller housing index has been showing small signs of improvement. While some may consider this a good sign, I am a bit skeptical. Why? Well, as we saw earlier today, mortgage rates are at 40 year lows. These low rates allow us to cover a much bigger principal with the same monthly payment. In the last 40 years mortgage rates have been as high as 18% and as low as 4.9%. The difference something like this creates on your purchasing power is tremendous.
Interest rates are low right now. Really, really low. I don’t think it can last forever. American consumers are too indebted, we can’t count on foreigners buying our debt with reckless abandon forever and, if a recovery shows up, there will be inflation, requiring a rate increase. I don’t think we are headed back to 18% mortgage rates, but sub-5% can’t last forever either. As interest rates increase, home-buyers will be faced with lower purchasing power, putting pressure on housing prices. Sellers are free to demand whatever price they want, but if they hope to sell they’ll have to meet sellers at a point in which sellers can afford the payment. Barring a significant increase in real per-capita earnings, if interest rates go up, buyers will either need to buy less house; sellers will have to lower prices; banks will need to lend for longer; or buyers will have to devote more of their income to housing. Something must give. I imagine that if that time comes, the rental market will be increasingly attractive as people hold-off on purchasing to wait for better interest rates. Note that this works in the reverse as well, as interest rates drop, people can afford more debt for their monthly payment, giving way to conditions favourable to appreciation.
Below you will find 3 graphs: one showing the effect of mortgage rates on purchasing power across the whole range of rates we have experienced in the last 40 years. The second shows you the same buying power, but ordered chronologically, based on the interest rates at the time. A plot of the CPI-minus-housing adjusted Case-Shiller is provided alongside it. Finally, interest rates and real Case-Shiller are graphed together from 1988 on. Please note that the mortgage rate is a running average of the last 3 months to smooth out noise. I chose 3 months because it is the same time-frame Case-Shiller uses. I expected to find a lagged inverse relation between mortgage rates and Case-Shiller, but, at a glance, there appears to be no strong relationship between them. I guess only regression will tell.
As always your feedback is welcome, either via email, or formspring. (No comments just yet.)
Negative Convexity and The Fed
So there’s this article over in FT Alphaville regarding the negative convexity of the Fed’s MBS purchases. No-shit, right? Callable securities exhibiting those features? Uhm… yeah, not so surprised. But, while Tracy does a good point of countering a lot of Krasting’s fears, I want to jump in to this one.
Tracy is right, the risk here is not so much an issue of negative convexity as it is an issue of the Fed borrowing short and lending long, whichcan have a positive carry in the short term, but leaves you with huge exposure if short-term rates were to rise. This is the same way the insolvent banks made it rain this last fiscal year. I’m really not so concerned about it for the Fed, because it’s not like they are going to violate their net-capital requirement. I know everyone likes to say that the economists there are incompetent, but I assure you they are smart people. As for the insolvent banks, well, let’s just let the FDIC speak for itself here.
So let’s talk refis:
- Continuing job losses and underemployment are keeping the consumer down and pushing down incomes. You—well, at least now—need income to get a loan.
- Tighter FHA requirements are likely to make mortgage credit harder to come by
- Elevated delinquency and default rates are likely to put downward pressure on LTVs
- The Fed suspending purchases will lower demand for MBS, which should widen the TSY to Mortgage rate spread. Calculated Risk estimates this at 35bp and I tend to agree.
- Even if, under a deflationary environment, interest rates continue to drop, they would have to make up the Fed-effect spread.
- A lot of people already refinanced.
- Rates may be off record lows, but they are still extremely low. Look!
OK! Now let’s talk prepayment. People usually prepay because they either refinanced, which we covered, or because they are moving and so they sell one property, pay off the loan and buy a new property with a new loan. I hate to sound like a CR dick-sucker, but, once again, CR has it goin’ on. Underwater homeowners face limited mobility! They also won’t pay at faster than scheduled rates because people have no jobs. There could be some prepayments coming from borrowers who are currently in default and will be executing short sales, but I don’t have data for that.
In conclusion, what do we have? Well, in an inflationary environment interest rates will rise and the Fed will get stuck with a negative-carry position. True, but we’ll have to consider the profits they made during the times of positive-carry. In a deflationary environment, rates will continue to drop, increasing the value of the Fed’s purchases, but in a limited way due to the terrifying negative-convexity boogie man.
I get it, you are worried that elevated levels of prepayments are either going to put additional deflationary pressures on the economy, but the Fed can always use OMO to add liquidity.
On the other hand, I get it too, you are worried that the Fed will get stuck in a vicious negative-carry trade and be forced to expand the money supply when they don’t want to. Not so concerned about this. They got those handy presses and it’s not like they have to keep the MBS to maturity. They are free to sell them into the market to mop up liquidity. Also, I know our collective attention span is short in the era of StockTwits, but deflationary environments don’t turn highly inflationary that quickly. Just ask Japan.
Finally, whatever happens will happen and it’s probably not going to kill us. So let the nice people at the Fed do their job. They are not trying to fuck you, they just make mistakes sometimes, you know, because they are human.
Stop panicking and do your homework, people!
