The Fed will have to pull its horns in the face of looming market instability arising

Outlook: The housing market is in recession, as starts showed yesterday. Today we get existing home sales, likely to continue the recent trend–a drop in Aug by 0.4% after -5.7% in July for 7 consecutive months of decline.

Two important factors–sales prices were still rising (7.7% y/y in Aug) for the 5th month, but likely starting to dip now, or soon, despite a small and dwindling inventory of unsold houses. Trading Economics agrees with the consensus forecast for Sept–4.7 million sales, from 4.8 million in Aug. The idea that the housing recession will lead the US into financial market instability and thus stay the Fed’s hand is a minority view that we talk about below.

Still, we smell a growing sense of risk-off, especially now that the dollar/yen has breached 150 for the first time in 32 years, if for only a moment, and fear of BoJ intervention is reaching the boiling point. Sterling is also at risk of re-visiting the recent low, 1.0354 from Sept 26, even if the BoE was able to withdraw support without a temper tantrum. We like to think that most of the time in FX, political stuff is disregarded. The famous case was the first shutdown of the US government when a Republican (Gingrich) had his feeling hurt by the president (Clinton)–and the dollar barely burped. But there are some political events that have massive and far-reaching effects, or potential effects, and those do affect currencies. It’s devilishly hard to identify them, though. Do PM Truss’ problems in the UK count as one of those cases? See below. We say probably not, but we have to keep paying attention. It’s one thing for a country like the Netherlands or Belgium to go without a government for months on end, but not a major country like the UK. The BoE is independent, but a government is not just one institution. Does the BoE continue to hike if government is in turmoil? Yes, probably, and a BoE official said yesterday that needed hikes may end up being less than now expected. But you can’t know that if you don’t know the fiscal picture and especially the energy cost to households.

Another area of concern is China just withholding its usual data releases, including GDP, while the Party congress is meeting. What’s going on–are they hiding something? The yuan keeps tanking. Finally, we are worried down to our toes about the current Republican leadership starting to announce that if they win the midterm elections, they will halt aid to Ukraine.

Bottom line, we have calls for the Fed to slow down to avoid a stampede–but in the absence of any evidence a stampede is developing. What we do suspect is that following St. Louis Fed Bullard is a good policy–he has been right so far. His current remarks indicate he expects the central bank to end ‘’front-loading” of aggressive interest-rate hikes by early next year. After that, “small adjustments.” He calls for deciding “what the reasonable level is.” As Bloomberg deduces, this means Bullard sees inflation and yields peaking in Q4.

If this viewpoint get baked into expectations, the US stock market can get a Santa Claus rally. Those who fret about Lag, including us, can stop holding our collective breath. What it means for the dollar is trickier. Again, if traders feel overloaded with them, a sell-off from extraordinary levels would not be abnormal.

Tidbit: The usual flood of newsletters contains more than its share of grand theories, with data to match. Economic data can be sculped into just about anything…

Some are interesting and some don’t make the grade. A paper sent to us by a Reader deduces that financial market instability is almost upon us as the consumer melts down, triggered by housing prices and conditions in the housing market. We don’t buy it.

The idea is that finance types think of “assets” as stocks and bonds, but to the average Joe, housing is the number one asset. Home values may retreat only 3-5%, as the experts predict, but is that an offset to the average Joe’s 401k having lost over 20%, even if showing signs of life recently?

The WSJ notes that most Americans are not even in the stock market at all. “According to a Gallup survey from this spring, 41% of Americans say they have no money invested in the stock market. Many of them can’t afford to invest: 75% of those with a household income under $40,000 a year say they have no investments, per Gallup. For others, it is a choice: 11% of Americans with a household income of at least $100,000 a year have nothing in stocks.”

So, only a minority having losses in equities and an even smaller minority actually engaging in buying/selling houses. In August, it was 4.8 million homes sold from a population of about 133 million households, or 4%. The recent bank earnings reports nearly all stressed that the consumer is holding up quite well–still spending and with consumer confidence on the rise again, even if inflation and rate hikes are what the Conference Board names a headwind. At what point does consumer spending and confidence get damaged by big, fat drops in asset prices?

We have a number of housing market statistics but let’s take single family home prices as closest to the heart of the average Joe. The Trading Economics chart shows the dip in July and August, but they look little different from dips in other years. In other words, the consumer is not facing a crash in this particular asset price. This doesn’t mean the consumer and his confidence will not flag at some point, but if the consumer didn’t freak out over the stock market dropping so far, it’s not clear the consumer will freak out over smallish house price drops–especially after having already gained so much.

What the consumer might freak out over is some kind of financial institution failure (or even just mess). This matters because the Fed has a mandate to maintain financial market stability as well as to manage prices and employment. So far the US hasn’t seen problems like Credit Suisse, let alone a Lehman moment. The only problem publicly identified is the financial market infrastructure issue of broker-dealers lacking the capital to assure liquidity in the money and bond markets. It’s a fair bet that 99% of the public has no idea what a broker-dealer is, let alone anything about their shortcomings. And the Fed and Treasury are working on it.

This is important because the paper puts it out there that the Fed will have to pull in its horns in the face of looming market instability arising from the consumer recognizing the “pain” Mr. Powell assured us is coming. It’s not clear what form this would take, perhaps having to sell the house after job losses? Closing retirement accounts and drawing down savings? That’s pain, all right, but it’s not “market instability.” In fact, it’s exactly what the Fed has girded it loins for. Rightly or wrongly, the Fed is looking at institutions, and the “public” doesn’t qualify.

Tidbit 2: In the UK, as so many have said, it’s not a question of whether the Truss government falls, but when. We now have a cabinet secretary (home secretary) resigning/getting fired and going out with a bang, a publicized letter excoriating the government for breaking promises and incompetence. It may be the first of many, according to Bloomberg, which takes unbecoming joy in these misfortunes.

The departing minister’s letter includes these statements: “Pretending we haven’t made mistakes, carrying on as if everyone can’t see that we have made them and hoping that things will magically come right, is not serious politics… I have concerns about the direction of this government. Not only have we broken key pledges that were promised to our voters, but I have had serious concerns about this government’s commitment to honouring manifesto commitments…”

The uproar persists, with the FT reporting “Tory MPS were threatened with expulsion from the party if they voted against the beleaguered government.” There is even talk of Boris making a comeback.

PM Truss has backtracked as much as possible, but utter failure dogs her every move–and that of Chancellor Hunt. Critics like to say the Reagan/Thatcher stance arises organically from Brexit, but that’s not credible–not when strikes in particular and popular uproar in general over tax cuts for the rich have nothing to do with Brexit and are British traditions down to their boots. We suspect that the Truss insult of the British as being the laziest in the world has a lot to do with it. You can criticize the welfare state without punching the public in the nose.

Wild swings in the 10-year Gilt are evidence that instability has been set loose and political posturing harking back to the 1970’s is not fixing it. Sweet irony–the self-appointed champions of capitalism are laid low by a key measure of capitalism. The Economist famously said Truss’ tenure had the shelf-life of a head of lettuce, an image repeated practically everywhere, even American news shows, which also aired Truss’ apology speech to Parliament.

One commentator explained US interest in British politics as reasonable, since we are embroiled in the first European land war since 1945. Facing an enemy speaking of nukes, it would be nice if the US’ main ally were less screwed up. (We are not sure we buy it. Maybe we just enjoy seeing Parliament behave badly and big shots get comeuppance.)

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