San Diego Housing Market News and Analysis
Is Inflation Dead?
Submitted by Rich Toscano on September 26, 2006 - 10:14am
Sorry about the radio silence this past week... I've been real busy getting the new portfolio management/financial advisory gig* off the ground**. What writing I did get a chance to do over at the voiceofsandiego.org concerned the Amaranth blowup, not housing, so I didn't link to it from here.
Now I am compelled to come out of hiding because of bond yields.
I made note a while back when the yield on the 10-year Treasury Note finally crossed the elusive 5% mark. The 10-year yield eventually rose to 5.24%, but as the below chart (courtesy of StockCharts.com) shows, it went into freefall soon thereafter.
What's going on? It seems that the markets, and the Federal Reserve along with them, have gotten it into their collective head that the housing slowdown will cause an economic slowdown, which will in turn reduce inflation. As if to confirm this viewpoint, the market's inflation harbingers—commodities—have gotten smacked around pretty hard, as the following chart of the oil price indicates:
I personally am very skeptical of this line of reasoning. Due to our tremendous deficit spending, the CPI (Consumer Price Index) inflation is heavily influenced by import prices. A slowdown here would not necessarily cause import prices to decline. As a matter of fact, import prices might rise if the dollar falls due to Fed rate cuts (which would reduce the yield advantage that the US$ has over other currencies) or to a declining confidence in the US economy. Rising import prices could easily offset the effect of a consumer slowdown on price inflation.
The decline in commodities could help ease inflation pressures, but the steepness of the price drop indicates that it has been driven less by supply and demand than by the "hot money" speculators being shaken out of the sector. If this is the case, prices could eventually start to creep up again as investors re-enter the commodities market.
Either way, there is scant evidence that inflation has subsided as of yet:
However, note that September 2005 featured a Katrina-inspired spike in the CPI:
For this reason, September's year-over-year CPI comparison will likely look nice and tame, bolstering the market's opinion that inflation has been vanquished. I believe this idea will eventually prove illusory, and that rates will rise again—but for now the inflation-is-dead crowd remains at the helm.
How this all affects the housing market is another topic entirely, and one that I will address in the near future.
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