Morning Report: Why the Fed is consistently high on its growth estimates 9/16/15

Stocks are flat this morning as the FOMC begins their two day meeting. Bonds and MBS are up small after getting whacked yesterday.

Mortgage applications fell 7% last week, as purchases fell 4.2% and refis fell 9.1%.

The NAHB Homebuilder index hit a post-recession record of 62 – the highest since October 2005.

The consumer price index fell 0.1% month-over-month as the strong dollar hurts commodity prices. Ex-food and energy, prices were up 0.1% month-over-month and 1.8% year-over-year. That is close to the Fed’s target, however they prefer to use the personal consumption expenditures data, which uses a different balance of goods to calcluate it.

Real average weekly earnings rose 2.3% last week.

When the FOMC releases their decision tomorrow, they will include their economic forecasts. For this entire recovery, the Fed’s estimates of future growth have been consistently high. IMO, the reason for this comes from the fact that the Fed’s models are largely based on prior experience which has been  Fed-driven inventory-based recessions since WWII. In these cases, inflation increases -> the Fed raises rates -> the economy slows ->  inventory builds up -> people get laid off -> a recession begins -> the inventory gets sold -> new production starts up -> workers get re-hired -> the economy recovers. These recessions are typically short and the recoveries tend to be V-shaped. This recession is  different because it wasn’t driven by the Fed raising rates and inventory buildup, it was driven by a bursting asset bubble. The issue with these  recessions is  that the problem isn’t excess inventory – it is bad debt and mal-investments. And these are typically longer and deeper recessions, with longer and shallower recoveries. Instead of  a V-shaped  recovery, you get a bathtub-shaped recovery. The economy recovers once the bad debt and bad assets are liquidated, which takes longer.

This leads into the latest negative equity report by CoreLogic. 10.9% of all homes with a mortgage (or about 5.4 million homes) have negative equity. 9 million (or about 18%) have a small amount of equity. 800k homes with negative equity would become equity positive if house prices increase 5%. Note that many of these properties may never sell (abandoned homes in rust-belt cities for example) so the effect on the real estate market will probably be muted. But that is one of the reasons why the inventory of existing homes for sale is so small. Negative equity has a drag on the economy be preventing workers from moving to where the jobs are because they cannot sell their house without a ding on their credit ratings. Just another example of the mal-investments that hold back the economy. The economy will accelerate as these mal-investments are liquidated and borrowers and creditors move on.

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