The Fed That Can’t

 admin  0comments  01.08.2015

As I mentioned last month, there would be no rate hike in September. While the imputed odds from the interest rate futures market were 1 in 4 as the meeting began, I gave it 1 in a million. No way should the fed tighten until emerging markets economies pick up. Why is the Fed holding steady as critics continue to argue (wrongfully) that they are behind the curve? The answer is not China. The answer is not Greece. The answer is.......Japan! Japan has been in a multi-decade depression brought on by a real estate and stock market bubble that popped in the 80s. Ever since, their interest rate policy has bobbed and weaved with every sign of strength and weakness in the economy. In 2001, Japan essentially invented quantitative easing. Simply put, this is bringing real rates below zero by buying mortgage backed securities. One crucial mistake they made along the way was raising rates on and off when signs of any strength appeared. The fed knows this is a recipe for disaster, which is why they have not raised rates in almost a decade. 2015: Just when our economy started to show signs of growth, the "emerging market" bubble popped. The world now finds itself in a DEFLATIONARY environment. While the USA is still hanging in there, there is no way the Fed can risk joining Europe and China and other emerging markets in a deflationary spiral. If this has been too technical, let me put it in plain english. The Fed can't and won't raise rates until the world economy is growing again. Despite all the talk, rates will stay low for a long time. What are the implications? For borrowers it is good news. If you have been unable to refinance , you still have plenty of time. For flippers and short term holders, your variable will suit you just fine. Even if the Fed is pressured into a 1/4 point rate increase at some point, rates will stay subdued for some time. For real estate prices this is good on the surface, if rates were the only factor in pricing. One leg of the stool is being pulled out as we speak. The foreign money that has added to demand here at home could quickly evaporate for several reasons. 1. Oil rich countries such as Russia who have been huge buyers of US real estate are hurting as oil has plummeted 75% from the highs. 2. The strength of the US dollar is making our goods and services more expensive hurting our exports. This could have a negative effect on our economy and our job growth. 3. The strength of the US dollar makes our real estate more expensive to holders of devalued currencies. The conclusion I draw is simply this. Trees do not grow to the sky. Most real estate booms end because of a spike in rates. Low rates should continue to support present prices. However, as the stool has lost a leg or two, don't be surprised to see a slowing of the mania that has fueled this recent real estate bull market. I am not talking 2008 or even 1993, both brought on by massive leverage. I will stick my neck and say a combination of less foreign money and a slower world economy will at the very least bring supply and demand into balance. 2016 will likely be a flat year, which after all isn't a bad thing. We do not need another bubble like 2006 to end as badly as 2008. A soft landing for the recent real estate mania seems to be the most likely scenario. Real estate and stocks remain the path to wealth building for the long term thinker. That is unless you think your .00001 return on your bank deposit will support a comfortable retirement. It has been an amazing run, time to stop and take a little time to breathe.