The coming collapse/price cuts?

Mouse, Assuming you taking about $1500 per sq ft range west of 3 in prime UES, do you expect market to be below Covid peak or above Covid peak? You will get your answer.

Mouse, Assuming you are talking about $1500 per sq ft range west of 3 in prime UES, do you expect market to be below Covid peak or above Covid peak? You will get your answer.

I don't think we'll see a 20% decline from here in the S&P 500, but I guess anything can happen. Nada?

I think a 10% decline across the board is most certain for most NYC property by early next year. Probably closer to 15-20% for the less desirable properties on the fringes. I also think inventory will continue to build.

We are seeing a significant decline for the less desirable properties already, with many not selling.

To my simple way of thinking, I try to understand why prices would go up or why they would go down. Currently I can't think of any scenario that would lead to higher prices.

We're doing deals here and there. But overall the market is very quiet right now. I'd call it a traditional summer market cycle, something we really haven't experienced in quite a few years.

Keith Burkhardt
TBG

Keith, Potential positives are
1. Return to office continues to gain momentum with slower economy and there will be more people in offices physically to keep their jobs. Remember, at the peak of covid, NYC got hollowed out and people are not still fully back.
2. Adams can finally figure out what to do with Bragg.
3. Some people may feel that they should taken out money from stock market and crypto before collapse and put into something they can live in. We had this after dot-com bubble.
4. Relative pricing of Manhattan vs burbs is looking much better.
5. Rents are hurting people with increasing rents reflecting a demand to live in NYC which is outstripping rental supply.

However I think the uncertainty of a Russian Ukraine war, inflation, interest rates are more tangible headwinds.

I also think there might be some fatigue in the buyer base from the hectic market we're coming out of.

It will be interesting to see the price chops in the fall. The market in Nowhere (and many places) is absolutely dead. One day the music stopped and nothing traded since. NY is probably more resilient but I don't see how there could be a good fall selling season unless economic numbers start surprising bigly to the upside.

Palm Beach County Florida has also slowed down to a snails pace. Inventory is incredibly tight, and things are still trading but nothing like 12 months ago.

There is also a large number of severely overpriced listings in low quality areas that are asking twice where they traded pre-covid. These are primarily condos, although on the intercoastal, not a prime location.

This was Aspen rental market in Covid. I hear it is down 30-40 percent in June with no takers.
https://www.aspendailynews.com/news/aspen-summer-rental-market-skyrockets-ahead-of-sold-out-season/article_b0395abc-aa2b-11eb-b910-af10b40f1646.amp.html

Anonymouse, along the lines of "the market can remain irrational longer than you can remain solvent," UES 3BRs may simply stop trading as buyers like you wait for a decline that sellers don't want to face. Some properties will have to trade, but they will be distress situations, and mainstream sellers will convince themselves that that kind of price cut isn't for their property. This game of chicken can last quite a long time, while rents continue to rise and children embiggen.

And west of 3rd in prime UES, there is very little supply at least of condos. Prices cuts are easier in area with a lot of new expensive condos as the developers have to sell. But we already saw that in Covid. If the rents were not be rising in Manhattan reflecting a lack of supply, I would have a different opinion. A deep recession can change it but Fed doesn't want a deep recession.

Keith, SE Price index change forecast July 2022 (presumably short term peak from contracts signed in March/April) to Jan 2023 prints?

Front Porch makes a perfectly cromulent point that sellers will hold out, but markets can and do come down. Old ladies die and the kids want the $5m from her apartment like yesterday, people get into financial distress, and the emotions take over such that people want it gone. The search costs are high bc most sellers are unrealistic, but as with the Barney's Warehouse Sale, there will be bargains if you spend a long time looking.

I wonder if one of the better performers will be UES prime coops. A 50% down payment isn't so awful when interest rates are 5% not 2%. Many never fell in price since 2006 - they just didn't go up and didn't trade. Which means they are down 32% due to inflation since '06. And maybe boards run by Boomers not the Silent Generation will be less like the Amish when it comes to modern novelties like in-unit W/D's. Or maybe not.

There are also people that need to move because they decided to leave the city. This can just be an organic occurrence based on changing family makeup, or simply a desire to no longer live an urban life. Perhaps those that are moving for less demanding reasons won't, and frankly shouldn't sell into a declining market.

@300 currently there is an imbalance between inventory and sales demand. I think that will start to adjust with time. Anecdotally I know real estate does much better in New York when the stock market is stable or better yet rising. If the S&P 500 can continue going in it's current direction, it will definitely help steady the ship. But to introduce a contrarian opinion, I've also had clients motivated by rapidly declining stocks. They'd rather put some money into a home they were living in, especially if they have long-term plans to stay put. So go figure. However these are typically people that don't have a lot of exposure to stocks to begin. I'm often surprised by how much cash some people hold.

Keith Burkhardt
TBG

This is more common that we think with market declines (not big crashes) short of job losses:
"But to introduce a contrarian opinion, I've also had clients motivated by rapidly declining stocks. They'd rather put some money into a home they were living in, especially if they have long-term plans to stay put. "

And I would also add the majority of buyers that I'm working with are people heavily biased towards owning the property they live in. I've just done two deals with clients that we assisted with the original purchase, then assisted selling their current homes, one at a loss, one flat, and they both bought new homes in Manhattan to meet their current family situation.

Even selling into a tough market, never once did they mention the possibility of maybe renting. There have been times I've mentioned to a client that renting for a year might not be a bad idea, no one has taken me up on it!

That said, the last couple of rentals we did were absolutely gangbusters! I will definitely not be farming out my rental business any longer! I believe we had 10 people who wanted our listing at the edge, it went above what we were asking without us even asking for more money! If you have a rental, please call me ; )

Keith
TBG

Before the pandemic we were talking about how apartments were being bought and rented at zero cap rates or even negative yields. That couldn't last. With rents way up and prices down, feels like we are closer to an equilibrium, no?

What do people think changed in supply demand dynamics of the rentals in $4k plus per month category? Many more renters despite stories of population decline in Manhattan? Perhaps population decline happened at the lower end with service industry / retail line workers and construction workers moving out as the economy was better in the sun-belt.

First in the big picture I don't think that many people actually moved out. And besides previous New Yorkers returning back into the city, I think the attraction of low rents brought first timers into the city in droves. But I'm just speculating.

https://streeteasy.com/building/272-1-avenue-new_york/11a. Look at the asking rent increase from last year's pandemic low.

Sorry ignore. It is a different listing despite the same unit number.

there is a serious inflation issue with food delivery though.

My recent order delivered by Grubhub from a fairly known barbeque joint

3 Meat sampler (+$2.50 brisket) $33.40
(+$5.95 brussel sprouts)

subtotal $33.40
delivery fee $3.99
other fees $1.00
tax $3.40

tip (15%) $ 6.11

Total $47.90

And lets ignore that it calculates the percentage rate of "tip" to include the delivery fee and tax.......

a meal cost of $33.40 gets to your hand for 45% additional cost

Now that venture capitalists aren't subsidizing food delivery, I have been going back to restaurants and am surprised how affordable it is given the talks of inflation in the news.

I refuse to use corporate middleman for restaurant delivery even though it means fewer restaurant choices for delivery. The ones I order from use their own delivery men.

The only time I do the delivery is with Uber eats, once a month for bagels because I get a $15 credit through Amex! However I was very surprised when I saw they double the price of cream cheese on a delivery versus a pickup!

I don't know much about this delivery space. However it seems like another unsustainable model that makes little economic sense.

Also just wanted to nite this was a very click baity title... "The coming collapse". ; )

This ain't Rome baby, this is New York City!

Note

Mouse is full of hope after not buying during Covid as nothing was perfect enough for him to buy. Not uncommon for people to compromise a great deal on a rental but wanting perfection when buying and then saying prices are too expensive.

@George - I think you hit the nail on the head re: cap rates
My condo right now sales prices are still flat/down, but rents (actual attained as I know the broker) continue to skyrocket... as much as +20% vs 2019 whereas sales prices are down 10%.
I am honestly astonished how much people are willing to pay for rent in Williamsburg. I think remote/hybrid/wfh has caused people to want to be in the city for the social life, but not care too much about how close they are to office/trains..

People who locked in a "cheap" buy during pandemic are going to reap those rewards for a long time, especially since they did it with "cheap money" ~3% or so montage if not lower.

Those who "got a good deal" on rent are now suffering the pain of reversion to trend line. Especially those who did not lock in a 2 year lease, or worse did the "net effective rent' game of 14 month lease with 2 month free.

Let's say normally a 2019 rental was $4000, would normally go up 3-5%/year and be at say $4500 in 2022.
So in pandemic bottom they signed a deal at $3000 to get it rented, and now the market recovered and landlord wants $4500.. or worse $4800-5000 as rents have overshot trend.

So now some of these people are looking at 50-60% increases and SHOCKED..

Steve, Since the rents are higher than pre-pandemic level, any thoughts on what caused the supply demand imbalance?

There are a shocking number of vacant units being held off the market on purpose. You don't need a large demand increase when you artificially depress supply.

30,

You may be talking about rent stabilized units. I don’t think they compete with $4k plus per month 1 bed room rentals.

It would be strange for free market rentals to be held back.

Mortgage rates at 4.1% for Jumbo with basic relationship discount of 25bps.
https://www.wellsfargo.com/mortgage/rates/

08/02/2022
Product Interest Rate APR
7/6-Month ARM Jumbo 3.875% 4.225%
15-Year Fixed-Rate Jumbo 4.125% 4.285%
30-Year Fixed-Rate Jumbo 4.250% 4.363%

Those rates are almost twice what I paid. Excluding the forced savings component of an amortizing mortgage, the cost of a home has literally doubled, almost overnight.

Well rates have doubled, but not your payment. Significant increase, though.

30yr 2.5/$3,951
30yr 5.5/$5097

For $1m

Actually $5368 @5% 30yr.

Haven't posted in these forums in a while, but surprised to see the crowd here not realize that a recession in this environment will be bullish risk assets and real estate. It's already being reflected in growth equity and crypto which appear to have bottomed or at least put in something near a low, and the market is telling you that the outlook for the terminal fed funds rate has likely peaked. For plenty of other structural reasons, mainly relating to chronic mismanagement of the US and EU fiscal sides of the house, there isn't a ton of room for balance sheet runoff or further significant moves higher in treasury yields either. Resi RE lags the fortune makers (aka, growth equity and crypto in this environment).

How would a recession be bullish for risk assets when Fed is net seller via roll-off of 10y bonds which will prevent it from going much lower?

I mean the yields much lower.

The market is telling you that the Fed will not be a net seller for very long, and indeed they haven't committed to any reduction target in the balance sheet because they know it is unsustainable. Currently the bloomberg terminal is showing a total Fed balance sheet size of 8.89tn, down from a peak of...8.965tn. Not too aggressive after all, huh? We could have a last leg lower in risk, sure, but ultimately the DXY must come down to prevent total destruction of markets in the EU and Japan. To do that, the supply of dollars must increase; by the laws of markets it is the only way.

July CPI is coming out on Aug 10th, currently projected to print 8.8% YoY from 9.1% last month. The first step you'll see towards the goal of getting DXY down is the Fed softening their jawboning on hikes, which will drive treasury yields lower, and eventually they'll claim it appropriate to adopt "neutral policy" which will allow them to silently resume a flat to expansionary stance on the balance sheet. When unemployment drifts high enough in the recession, they will again adopt a loose monetary policy stance, as they always have and must adopt long-term in the current debt heavy global economic regime.

How is that different from your view last year that fed wouldn't be able to raise it beyond 1% or so? We saw 10y at 3.5% which may prove to be the peak in the next year or two. I was also thinking a year back that the short term rates couldn't go up much but I was clearly wrong in under-estimating inflation and what fed will need to and can do.

Aggressive rate hikes like we've seen obviously were not the Fed's preference, and that was driven by inflation spiking to 1980s levels faster than anyone thought would happen. It's all about the trend in inflation now for risk markets though, as that will drive the Fed's decision making alongside fiscal restraints for balance sheet and yields. We're now seeing in commodity and energy markets how quickly rate hikes have induced the type of demand destruction that will temporarily stem inflationary pressures, as energy has been the largest CPI driver. MoM CPI for July is expected to be just 0.2% as the energy component will be negative. When I reference what "the market is telling you", I'm noting that fed funds and eurodollar futures are both currently projecting between two and three rate *cuts* in 2023. What will risk assets do in that environment after the blow off rally following covid? Not going to be bearish real estate, I'll tell you that, and that's just being priced to happen within 18mos.

Thank you for explaining. That seems to be current wisdom (fed funds go up another 1% and then come down to sub 3%) but this view of fed fund rates doesn't say much about impact of balance sheet roll-off. Fed has barely started and they are not stopping for 1 year at least (1 Trn reduction) barring a major recession. And while we have seen the peak in inflation, current fed fund rates are still too low even if the inflation comes down to 3.5-4% in the next year.

My view of Manhattan real estate being relatively stable is much more supply and demand related in $1000-$1500 per sq ft resales as reflected by current rents.

Inflation numbers are a lagging indicator. I wouldn’t be surprised if the next CPI report turns out to be better than last month.
The Fed can mess things up by increasing interest rates. But then again the Fed has been messing up big time with their insistence for sometime that inflation was transitory. Powell is not an economist.
By early next year rates will come down.
As far as the stock market, by the end of 2022 it will show a vast improvement.
Be in the market before the Fed announces a rate cut.

"And while we have seen the peak in inflation, current fed fund rates are still too low even if the inflation comes down to 3.5-4% in the next year."

The economy cannot tolerate positive real rates with debt/GDP at these levels. That's been a key driver behind all of the post-GFC monetary policy decisions, and especially the post-covid decisions. Powell himself characterized the current rate as "neutral" in his FOMC presser last month. It's brutally unfair for the bottom 90% of American earners, but it is simply the world we live in. Put another way, if inflation comes down to, say, 4-5%, you'll have idiots like Krugman et al coming out of the woodwork to say well actually this is a fine neutral inflation rate now and the Fed can keep rates low because it helps fund our deficit financed pet projects in congress.

So basically a view that real interest rates will remain negative as they have been for a while. What is your 10y forecast 1y from now (08/03/22 today). I am thinking 3% with rate vol coming down from the current level which will help reduce mortgage spread over 10y treasury to more normal levels. Thank you.

The market's 1y fwd 10y rate is 2.87, I think that sounds a bit high considering what I believe the market's reaction to any cut would be (steep, accelerating rally in duration which pushes long yields down). Market is pricing in a peak in fed funds by February and a >50% chance of a cut by June. Even if we get another 100-125bps before the terminal fed funds, I think a single cut from there would send long yields lower than where they sit today as the established path forward would be so clear.

Interesting analysis UWS_er. Fed ditched forward guidance, so is that terminal still around 3.5%-3.75%? I am wondering if that is too low to contain the inflation that is out of the bottle.

So fed is anticipating hiking enough to cause a noticeable slowdown, one that requires stimulus afterwards. Inversions confirming this concern. Not sure risk assets are properly pricing this in tho

Noah, Do you mean terminal 3.5-3.75% for this rate increase cycle?

"Interesting analysis UWS_er. Fed ditched forward guidance, so is that terminal still around 3.5%-3.75%? I am wondering if that is too low to contain the inflation that is out of the bottle."

The Fed's broad goal is not to contain inflation beyond the point where it's an acute political issue like it is currently. The Fed spent years telling you that they wanted inflation, and they do. It is the only way to reduce the US's horrible debt levels without causing huge credit issues thru deflation and intense deleveraging. Unfortunately for the Fed, they are 1) run by economists who are not very good at their jobs/don't tend to fully appreciate second-order market effects and 2) are limited to imprecise tools that cause problems which tend to get ignored by Fed officials until it's too late. BUT - as stated - the goal that was out in the open and plain for years was to cause inflation, and voila they achieved it.

What does that mean now? Well, again, I'm sure you'll have the Krugman crew come out and take a victory lap if CPI goes down to the 5% range and come up with some nonsense to declare that this is an acceptable inflation level. This serves a variety of political goals for both sides of the aisle, but mainly the one where deficits can continue to be financed by rates that are below the natural rate of interest. If real rates went positive, the US would begin to have issues meeting its entitlements, military spending, and interest expense obligations in full without a spiral of additional debt issuance to meet payments which continues to increase its interest expense, and so on. Our tax receipts nominally grow relative to the interest expense when infl>interest. The fed funds futures market is still putting the peak rate right now at just under 3.5% before cuts start kicking in by the back half of next year.

Was chatting with colleagues earlier today about how this feels like we might enter a 2019-type period where the market bullies the hell out of the Fed who was talking a tough game at the time, as well, but ultimately folds like a cheap suit to the bond market which demanded cuts. Late-2018 gave an ugly equities dump, and we're starting to see stocks rally as if they're looking thru anything that the Fed can offer on the hawkish side now to what the bond market is calling for next year.

UWS, What are saying was true when the 10y was below 2% despite Powell's testimony in November 2021 about raising rates to kill inflation. How did the bond market get it so wrong? 10y went to 3.5% and now the reasons you are saying is back to 2.75% in a month or so. Is it true that bond market also does a terrible job of forecasting rates as there is a lot of other people's money (pension, indexed etc) and permanent long money (insurance, pensions) in the bond market? Of course, the market participants have to talk like they have some forecasting power. Otherwise, they will be fired.

You're asking why there is volatility in bond markets. There is always structural volatility in any market. In this particular case, the Fed for a while made it quite challenging to predict a terminal rate due to their cagey-ness and intentional vagueness over the extent to which they would push policy. In that environment, there was just an upward sloping fed funds futures curve and no real view on when cuts would come. The key shift now is curve inversion showing up everywhere - fed funds, treasuries, eurodollar futures - which is the bond market telling the Fed that they're done. The fundamentals of markets bow to no man, including Mr. Powell and Madame Lagarde.

Remember what I said from the start - ultimately the DXY must come down from current levels to avoid market collapse. There is one way to do that, which is to increase the supply of dollars. It is what it is. Powell has said in the past that he wouldn't be hiking rates while expanding the balance sheet, and rightly so. The market is now simply reflecting when those hikes will have to stop. "Data dependency" and removing forward guidance is just fedspeak for "we'll turn this ship around faster than you can blink when we need to".

Thank you for sharing your thoughts. I understand there is structural vol in any market. For 10y, structural price vol is 4-5%. But we have had price vol far in excess of that (10% plus). All I am saying is that market fwd levels for bonds are as bad as Fed forecasting in uncertain environment we are facing today. I am not sure how right my estimate of 3% for 10y in appx 1 year from now will be.

Separately, Mouse disappeared after starting this fun thread.

UWS_er, welcome back. Good to hear your POV, but mostly I’m just trying to reconcile the UWS_er of today with the one from 12 months ago when 5-10yr forward rates were ~1%.

>> The almighty market is notoriously horrible and forward curve projections…. I wouldn’t put much weight into forward rates 10yrs down the line. A cursory glance at the fiscal position of the US makes it quite clear that rates either can never get that high again unless we have some sort of “great reset” scenario in the aftermath of a high and sustained inflationary period, in which case everyone sitting on a mortgage denominate in pre-inflation dollars will be happy anyways. The only other option is a quick spiral into US Treasury default if the Fed actually allowed rates to go that high, so of course they won’t and the release valve is likely the dollar. Until that outcome hits, no worries on mortgage rates.

I see consistency in UWS_er posts. Depressing, but I concur. While I don’t have children, I am sad for nieces and nephews, but then I realize I now sound like my grandparents. What they live is all they will know and it will likely still
be pretty darn good from the most basic perspective.

Yeah, I see the consistency. Same certain outlook, no matter previous proclamations of what “can never happen” actually happened less than 12 months later. And an interesting shift from “forward rates are useless” to using forward rates to make an argument. Those are the parts I’m trying to reconcile.

UWS_er, what is your take on future inflation? Here’s what you said a year ago:

>> Well 10y TIPS are currently yielding -1.04% and haven't traded above zero since March 2020. They will not trade above zero for many, many years.

They’ve gone positive now. And if we look at the forwards market, inflation will be below 3% in short order. It seems like you are looking to the forwards market to back one side of your outlook (yields coming down) but ignore the associated one which runs counter (inflation coming under control).

300 - yes. I don't see us topping out that low.

Great thread. Need to digest all this at a proper hour lol

UWS - "Remember what I said from the start - ultimately the DXY must come down from current levels to avoid market collapse. There is one way to do that, which is to increase the supply of dollars. "

I think there is crazy FX stuff going on that is way over my head, especially with yen and usd swaps, etc. Feel like this is a controlled demolition, will go in stages. Fintwit community mixed, Im of belief this is a inflationary bear market, stage 2ish, lots of rallies making the case that all is ok. Not sure how this ends tho if/when fed realizes 3.5% may not tame 9%+ cpi. Energy and rentals are a big part of inflation #s right? So those two sectors still doing their thang.

Lots of moving parts here. I do think one thing is for sure, whatever outsice NYC real estate markets do, nyc will be less severe imo for the fact that we still have deflationary forces upon our markets that have resulted in barely any price movement pre covid to now, vs other markets that went parabolic and are now sharply correcting

@nada - I see your points, but I think UWS_er overall point is that it all smooths out to low interest rates in the long run to sustain we society’s undeniable preference for mortgaging future generations standard of living than paying for what we consume today. All these blips are just noise that deflects from the ultimate trajectory. I could be misunderstanding UWS_er for sure; hopefully they (can’t believe I am succumbing to the grammatical blasphemy) will come back and respond to your specific questions.

The idea that rates will be held down to ensure that debt can be serviced seems to be a for of the Household Budget Fallacy. This is not how finances work for governments which issue their own currency. UWS_er's logic is completely wrong.

Now I am pulling up a chair and taking notes. I would love a substantive debate between WoodsidePaul and UWS_er. In the interim, I am googling "Household Budget Fallacy."

@noah this should be around table event on Urbanigs vlog.

The more I learn the more frightened I get ; ) but somehow it all seems to work out.

Jeez... a round table in Urbandigs...

@keith - "somehow it all seems to work out." Until it doesn't . . .
I am pretty sure it will always work out in my lifetime, and I wonder if a natural disaster won't work it out for the country (and humanity) before we hit the point where our finances don't work out. I've just thrown up my hands and pretty much tune it all out. If you can't beat them, join them! On a micro level, I am now voting for all sorts of spending in our building because I just don't care. Gym? Sure! Roof deck - well, we definitely need that. Courtyard? How has the building survived for 100 years without landscaping! I am pretty sure the banks will float us an even bigger mortgage in 5 years when it comes time for the balloon payment, and by that time, interest rates will be negligible, right?

Wow lots of response here haha, just catching up now.

@inonada indeed surprised by the positive real rates reflected in the TIPS curve, though you'll note that spot interest rates still remain deeply negative when comparing fed funds to CPI which projects to continue indefinitely. TIPS ultimately were not where this monetary repression of interest

ugh had a lot of my comment cut off...will try again in a bit when I have some time

Ok one more try...

@inonada indeed surprised by the positive real rates reflected in the TIPS curve, though you'll note that spot interest rates still remain deeply negative when comparing fed funds to CPI which projects to continue indefinitely. TIPS ultimately were not where this monetary repression of interest rate held under inflation was expressed, and I think my view then remains broadly consistent with my view now that positive real rates are more or less not sustainably possible given the poor fiscal position of the US. That said, you are correct that my view on TIPS last year was not what ended up being the red alarm signal for the Fed. If the Fed can get spot Fed Funds rates above YoY CPI sustainably, I will be happy to have been proven wrong on this real yields front as it would reflect a healthier economy, but I find that scenario unlikely despite it being the historical norm. Even when inflation comes down from current levels, there will be a chorus of people looking to loosen policy before it gets to 2% because the other option is quite ugly for essentially all markets, and we’re past the point of being able to deal with this in a painless way so inflation is the path of least resistance. Market forward curves 10 years out on inflation I think can be taken with a significantly larger grain of salt than ones that are projecting Fed hikes/cuts within 12 months, so I also don’t view using the Eurodollar and fed funds futures as a good hint now as inconsistent. In fact, the “data dependent” shift at the latest FOMC only bolsters that view.

More broadly, it’s not controversial to look at the negative nominal rates in Europe and Japan and the straight negative trend in yields in the US since the Volcker shock and think that we’re near a breaking point on the extent of interest rate manipulation that can be tolerated by markets, so the next release valve is clearly currencies which we’ve seen in the GBP, EUR, JPY already this year. USD as the global reserve has gained relative to other weak fiats but fallen relative to commodities and energy in 2022. Given that, how would we fundamentally reach a point where yields remain low enough to allow the US to finance its deficits, but for positive real rates to be achieved, *and* for the dollar to not grow strong enough to crush global economies therefore eventually our own? From first principles, I don’t have an answer to that question, so my view that interest rates will be forced to trend lower over time has not changed. The timing of that shift likely coincides with official recognition of recession or high recession risk, which is why I think it’ll be bullish risk assets.

@WoodsidePaul – didn’t think we were going to get an MMT argument in here after that worldview has been so thoroughly discredited through the events of the past two years as far as I’m concerned, but here we are. Unfortunately that “fallacy” is only so in the eyes of Stephanie Kelton et al, and without the ability to alter tax policy through a divided congress rapidly and with superhuman accuracy, the idea that governments need not worry about budgets or revenue in relation to spending is simply not a realistic one in my view. Even with that magical power, I’d never trust a group of academic economists to guide the invisible hand of global macro markets. Again, the laws of markets bow to nobody.

Mouse is just a curious mouse. Mouse is not full of hope to buy a house. Mouse happy to rent (for now) and kick the can around about leaving Manhattan (but to Somewhere, not Nowhere). !

I am really just confused why the cost of living keeps going up without any fallout. How much higher can rents and real estate can go? I assumed rents couldn't go higher, and thus real estate cannot go higher. I've been wrong on that in the past.. just curious why I will be wrong again... !

The conclusion I took away from the prior thread was wages have gone up tremendously, so demand has gone through the roof over last couple years. But if the markets decline, tech corrects, capital markets activity is reduced... I would think incomes would be down. And you have a further squeeze on demand by mortgage rates, strong dollar, $10 dollar milk etc. Further I would have thought rents cannot go up for affordability reasons (brokers tell me most application rent applications come in at straight at the 40x line) so there shouldn't be room in budgets for rents to go higher. But higher they go...

Re markets.. I think the S&P bounce here is a headfake. If it were to go much higher (e.g. SPY 4400) I would acutally short it. My gut is telling me S&P earnings going up 20% over 2YRs with so many headwinds is too optimistic. We just exited a decade of ZIRP and the markets have taken it in so much stride, as if there is nothing to see here. Perhaps the Fed gods are really gods and can balane the economy on the tip of their nose.. perhaps not.

Can anyone translate for me: Are WoodsidePaul and UWS_er in agreement that the "Household Fallacy" is itself a fallacy? This is the point on which I diverge with my more optimistic discussion partners, so I am very curious to have clear statement on this point. I just cannot wrap my head around the notion that we don't need to worry about deficit spending because we are going to grow our economy indefinitely, but my more optimistic discussion partners assure me that we can. In other words, I do not subscribe to the "Household Fallacy," whereas my more optimistic minds do. I am reading both WoodsidePaul and UWS_er to be in my camp, but my reading comprehension skills might not be as sharp as I once imagined them to be.

And IF both WoodsidePaul and UWS_er agree that deficit spending is not sustainable indefinitely, are they disagreeing as to when the breaking point will come? Or are they disagreeing on what form the breaking point will take - i.e., what will it look like and what does that mean for each of us in our daily lives?

No, I totally disagree with what WoodsidePaul said. He takes an MMT view, which is that governments with the ability to print their own currencies need not worry about revenues or spending when it comes to debt service, because they can always print money to service debts. The theoretical limit on that would be inflation, at which point the prescription in that line of thought would be tax hikes to remove money from the consumer economy to tame inflation, but not curbs on money supply expansion to service debt. I think this view is pretty inconsistent with how policy is decided on and implemented in the real world, requires incredible accuracy in policy choices to not lead to disaster, and even disregarding those issues is called entirely into question in its accuracy given what we've seen happen post-covid.

This is really just a dressed-up version of the centuries-long tendency of governments to resort to printing currency to satisfy debts in lieu of austerity. It has never ended well, and despite the US's structural advantages as the issuer of the global reserve currency, we still cannot ignore the natural laws of markets required to make that idea reality.

So, we agree governments have a tendency to resort to printing currency to satisfy debts in lieu of austerity. We (I think) agree that this ultimately cannot end well, so here is my question: Do you believe this tendency has ended? If not, when and how do you think it will end? My novice mind is thinking that high interest rates would be how it will end, but I am reading your posts to say that those high interest rates won't materialize in any lasting form?

I don't think it is productive to discuss satisfaction of debts, because clearly the market is accepting U.S. debt and dollars right now and fiscal policy pretty much is what it is. I think this has no bearing on Fed policy in 2022.

I really do think that the Fed will do whatever it takes on rates to break inflation. My main dispute was the idea that there is some sort of cap on interest rates because of debt service costs. I don't think this is true. I have also heard ideas that the Fed will cut rates if we go into a recession. I only think that the rate hikes will stop when inflation stops - debt service costs and economic growth be damned. We learned in the 1970s that poor growth alone doesn't always kill inflation.

So my view is that sustained high interest rates would come in direct conflict with the amount of debt that's built up in the global economy as well as some other more complex factors in financial markets that I don't need to get into. We've largely financed the world for the past 50 years through rolling over interest and gradually lower rates, and now we sit at a table of >100% debt/gdp in every western region, and in many cases much higher. There are other entitlement payments and military spending obligations that the US can't default on, and the US can't default on its interest payments. Tax receipts are heavily reliant on capital gains taxes, so we can't have equities sustain a decline for too long either to make this all work. Worse yet, if the dollar gets too strong it collapses economies in Europe and Japan, so that's another constraint.

Where that leaves us (if you assume no appetite for fiscal austerity, which I don't think anyone is projecting) is with two ways out of the debt situation, through deflation or inflation. The first one involves a really messy unwinding of the economy with a lot of unknowns for the global financial system, and the second involves a lot of quality of life deterioration for people with few or zero financial assets who rely heavily on wages, but a continuation of the financial system that gradually gets de-levered through inflation. The debts stay denominated in the original nominal amounts, but the GDP and tax receipts grow relative to those amounts over time with inflation, so ultimately debt/GDP declines and tax receipts relative to interest expense increases to a point where you can gradually raise interest rates. We're not near that point yet though, and it will take a long period of monetary repression (rates below inflation + expansion of money supply) to get us there. I am pretty confident that monetary policy makers globally will choose the second option. The likely near-term decline in inflation doesn't really alter this view for me at all, as it will still sustain well above 2% and this is likely the first of a few significant inflation spikes we see in the coming 10-20 years.

I hope WoodsidePaul’s outlook prevails (which I think is that high interest rates are used to tame inflation in a lasting way). However, I don’t discount the political realities of UWS_er’s outlook, in which case I will just carry on as is and brace myself for the next revolution which, quite frankly, is probably overdue. As I’ve noted before, if/when it comes, I will offer no resistance.

Wow jobs. Fed in a spot now

The international system political pressure to not have US rates be too high is the piece that I don’t feel the media is capturing at all. I heard a Larry Summers interview last week where he alluded to how US ability to use interest rates as a domestic tool is constrained by the the effects US rate hikes would have on other countries’ systems, and I did not fully understand until digesting UWS_er post. I still may not be fully understanding, but there you have it. One part of UWS_er outlook makes no sense to me - that portion where he (sorry, I can’t succumb to the “they” as hard as I try without explicit direction from the antecedent person) says that the system ultimately gets delevered through inflation. Why would the politicial pressure that got us here (human nature) not continue to increase debt perpetually until collapse (whenever that may be, but not in my lifetime) such that the system is never delevered?

As an aside, whenever any young person seeks my advice as to where they can have most impact within USG on international affairs, my answer is alway “Work hard and get thee to Treasury.” In my limited experience, whenever they took a firm stand in interagency negotiations on any issue, all other agencies would back down on each’s relatively narrow mission objective for whatever the issue at play was and the discussion was over.

In 1945, US debt was at ~120% of GDP with the (equivalent of) Fed funds rate at 0.x%. Over the next 35-40 years, it dropped to ~30% , bottoming at about just the same time as Fed funds peaked at ~18%.

Apparently, last time around the US didn’t go the hyperinflation route. Perhaps that’s because it doesn’t actually really solve anything. And perhaps high debt-to-GDP is a feature, not a bug, of low rates. Just as the Fed encouraged the peanut gallery here to gorge on cheap debt to combat deflation, perhaps that was the intention with Uncle Sam too. And now that everyone got a little too tipsy, stoking inflation, perhaps the Fed’s intention is to create a bit of belt tightening with higher rates, not just for the peanut gallery but also Uncle Sam.

Maybe Uncle Sam captures the Fed and we go Venezuela, I dunno. A outside possibility, I suppose, but not one where I would count on one piece (cheap debt despite inflation) without considering all the rest. I am reminded of last year’s thread where the zeitgeist was “We’re all Japan now”, considering one piece (ZIRP forever) without the rest (shrinking population, deflation, declining asset values). Perhaps we can all agree that we’re not Japan anymore, right? Probably not.

What does this all mean for stocks 5-10 years?

"Apparently, last time around the US didn’t go the hyperinflation route."

Yeah, just a four year inflation cycle that peaked at 19.7% CPI after a two year 12.7% peak inflation cycle and then another two year round of 9.3% CPI...easy peasy, everyone's happy. We didn't have anywhere near the globalized economy we have today, either, which ultimately suppresses consumer prices.

What the government did do overtly and to great effect in the 40s and 50s is something that I think is on the table in the coming decade, which is "macroprudential regulation". Really great branding btw, reads as American as apple pie. Who could be against macroprudential regulation? By our all-knowing PhD economists in charge, too? As the Fed loses the ability to credibly expand the balance sheet in exponential fashion stoking inflation themselves, they simply shift the burden of suppressing interest rates to commercial banks. By the stroke of a pen, commercial banks can be forced to carry a significantly higher balance of USTs on their balance sheets and hold those treasury balances relative to their overall deposits, which continue to grow nominally as inflation increases. They'll get an administered spread relative to their duration loans, and just have to be happy with it lest they run afoul of regulators. The result is the now quasi-nationalized banks doing the Fed's job of keeping rates low and gobbling up US debt, allowing the treasury to continue servicing its debt without issue.

High debt/gdp, historically, has *never* been a feature in the long run. The Japanification of the west continues on unabated, and frankly the only that likely timeline has only accelerated given the potential European winter energy crisis brought on by the Ukraine invasion that could force a loosening of policy in the EU much more quickly than Lagarde probably would like, which then forces Powell's hand due to the dollar strength constraints described in previous posts.

>> What does this all mean for stocks 5-10 years?

I’m not sure. Mostly, I look at possibilities of what can happen and try to position myself for a positive outcome regardless. If you look at the ARM thread from a year ago, I wasn’t predicting that the Fed would increase rates, just that it could and likely eventually would. Some people proclaimed it could never happen, that the Fed would not act according to its very plain and transparent mandate. Yet here we are, and still we hear the same. Maybe there’s a secret cabal at the Fed whose underlying goal is to let inflation run amuck despite their mandate, repeated public pronouncements, and guidance otherwise. But perhaps they’re gonna simply do what they say they’re gonna do. Prepare yourself for both I suppose, but I’d count more on the latter than the former.

What UWS_er says Krugman will say:

>> Well, again, I'm sure you'll have the Krugman crew come out and take a victory lap if CPI goes down to the 5% range and come up with some nonsense to declare that this is an acceptable inflation level.

What Krugman says Krugman will say:

>> But the good news we’re about to get about short-term inflation isn’t evidence that the strategy has already worked, and alas (I’m usually a monetary dove), it offers no justification for a pivot toward easier money.

My money is on Krugman being right about what he’s gonna say if/when it happens.

Point being, don’t fight the Fed. If they say they’re gonna do X, set your first-order plan around them doing X rather than the opposite.

Announced action.
$95bn balance sheet reduction starting next month for the foreseeable future. So call it 1 year of reduction min.

Fed officials post Powell: In the range of 75-100bps to go this year and stay there.

Unemployment 3.5 percent. It seems no reason for them to stop raising till we see at least 0.3 percent uptick. And no reason to lower till min 4.5 percent.

What Krugman has already said:

https://www.nytimes.com/2022/06/03/opinion/inflation-federal-reserve.html

"As a result, a number of economists have suggested that the inflation target should be raised. For example, in 2010 Olivier Blanchard, then the chief economist of the International Monetary Fund, made the case for an inflation target as high as 4 percent. I made similar arguments to the European Central Bank a bit later."

UWS, I am generally a dove on interest rates but in the next 6 months (as long as I think I can forecast under current unusual economic circumstances) I have outlined some facts in my previous post. 10y could be 3-3.5 range.

If you actually read the article, he’s discussing how the world arrived at 2% and that 4% would have been just as fine w.r.t. growth. The advantage of the latter being more room to combat deflation with negative real rates beyond 2% instead of having to resort to expanding the Fed balance sheet, as we did over the past dozen years. But now that the world has arrived at 2%, you can’t really take it back, and he wouldn’t either. From the same article:

“Giving up on the 2 percent target might risk losing this anchor. Being honest, if I were a decision maker at the Fed, I would probably have the same concerns.”

Back in July of 2019 there was a lot of complaining how dead the market was and explainers said tax change had sucked a lot of demand forward with transfer taxes going up July 1st.

July 2022 resales were a hair below 2019 levels and citywide New Dev sales were 37% below July 2019.
https://therealdeal.com/2022/08/05/new-development-sales-plummeted-30-in-july/

How sad is it that it didn’t even occur to me that the Fed would stay true to its mission and its independence. In any event, I’ve read more on effect US interest rates have on other countries’ financial systems (significant), but still don’t understand how that as a constraint on the height to which US interest rate can rise. And, despite everything we have seen over the past 5+ years, I still maintain faith in US institutions, so I come down on the side of those who believe we are in for rate increases, even if such increases push us into recession.

Thoughts on path from here?

10-year treasury at 3.7% and 2-year at 4.2%. So the Fed appears willing to use higher rates to fight inflation, I would say.

WoodsidePaul was right indeed.

1 BR Rents though the roof. How much will this offset the hit from higher mortgage rates?

https://streeteasy.com/building/the-hilary-gardens/20l
https://streeteasy.com/building/the-hilary-gardens/31l
https://streeteasy.com/building/prism-at-park-ave-south/3k

And a price cut in asking rent after 60% increase in the ask from the pandemic.
https://streeteasy.com/building/601-east-20-street-new_york/03e

Another 50%+ increase in ask from 2015.
https://streeteasy.com/building/7-peter-cooper-road-new_york/12g

Rents in Manhattan tend to be all over the place in normal times, but at the moment it feels even more especially the case. Compared to 2019 at this time, both SE and Miller Samuel have rents ~15% higher than before. I would guess that is a slight underestimate of reality on the ground (20-25%?).

Does this take some of the bite out of higher rates? Sure, but much of it remains.

I remember Krolik pulling the trigger in 2020 because she saw a cap rate of 3% (assuming 2019 rents, I believe) against 3% 30yr fixed, which was attractive to her. Let’s use that to illustrate.

Suppose annual rent used to be 5% of purchase price, with 2% in cc+tax, yielding a 3% cap rate. To first order, say that prices, cc, and taxes are flat. Rents are up 20%, meaning annual rent is now 6% of purchase price, yielding a cap rate of 4%. So better, but now it’s 4% cap rate against 6% 30yr fixed.

If rents were up 60% (which definitely is not the case broadly, though it might be in a few cases), then it would be 8% rental yield => 6% cap rate vs 6% 30yr fixed. So we are a ways away from rent increases driving people into buying. If anything, there have been lots of articles recently about the opposite. Even with 25% rent increases nationwide, the change in balance is shifting lots of would-be buyers into renters.

Jumbo 30y still sub 5 with 25-50bps relationship discount.
https://www.wellsfargo.com/mortgage/rates/

For fun, try this buy vs rent.

Assume $2.8mm purchase price with transfer taxes, mansion taxes etc plus Keith B rebate. 25% down. 5.25% mortgage 30y. $15k mortgage tax benefit. Call the principal payment initially wash with insurance and upkeep over time to keep things simple.

https://streeteasy.com/building/1289-lexington/5a