10 Dec THE FED MEETING, FUNDING MARKET AND OER
It is often written the markets are a microcosm of the myopicy of current perspectives. The issue at hand is to recognize the next myopic dominating view.
Will it be the dysfunctional funding market, a market that is providing the necessary liquidity only because of Fed intervention? December 16 quarterly taxes are due. Moreover demand for funds/liquidity is greatest at year end. Will funding costs spike as they did in September? These surging costs were quickly reduced by the first Fed intervention since 2007, an intervention that is now occurring daily at levels much greater than anticipated.
Most will acknowledge it is regulatory fiat, the result of Dodd Frank, which has destroyed overnight liquidity. But the question that still has not been answered is why the sudden demand for liquidity/funds, the first since September 2008?
Changing topics for the first time since 1972 wage gains are greater than 30-year mortgage rates. Economics 101 states when this does occur, real estate values increase at a rate potentially greater than the rate of inflation which then produces yet even more inflation. As noted many times residential real estate prices in secondary and tertiary cities are still below 2005-06 levels.
Most value their net worth by the value of their homes. Owners’ Equivalent Rent (OER) or what someone can rent their home for if it was indeed rental, is closely correlated to home values. OER is 31% to 33% of accepted inflationary indices and the benign levels of OER is a major reason for “well anchored inflationary expectations.”
What happens if OER suddenly accelerates? Will inflationary expectations rise, a rise that then morphs into cost push (wage) inflation, the scourge of the inflationary late 1970s? Residential real estate values surged during the period however the real increases (after inflation) was relatively muted.
Wednesday is the conclusion of the FOMC meeting. No change in monetary policy is expected. Will the Committee comment about the issues surrounding the repo market? I am relatively certain no remarks will be made about OER.
Can I remotely suggest the overnight funding market is beginning to discount the increase in OER or some other issue that is or is about to cause an unexpected market disruption? All must remember it is the unexpected that shatters current illusions.
Last night the foreign markets were down. London was down 0.98%, Paris down 0.92% and Frankfurt down 1.48%. China was up 0.10%, Japan down 0.9% and Hang Sang down 0.22%.
The Dow should open moderately lower ahead of several central bank meetings and trade deadlines. The 10-year is up 5/32 to yield 1.81%.