Thursday, October 18, 2007

If the Fed cannot find the inflation – Look at the housing problem


CPI numbers were reported yesterday but they were right in line with expectations. CPI ex food and energy was 2.1% which was back down to numbers that are similar to 2005. The CI overall was at 2.8 percent which is higher than the Fed target but still below levels that were seen in 2006. The real rate of interest is positive which suggests that monetary policy s not too loose and the implied inflation in TIPS is similar to current CPI levels . If there are no inflation fears, then we have a green light for the Fed to lower interest rates to meet policy objectives on the real economy. This is one of the main causes for a gain in eurodollar futures after a sell-off.

Here again the main issue is housing. The numbers are bad and we are starting to see earnings of banks decline. Housing starts and building permits are both down relative to expectations. These are the expectations that have already been beat-up. The decline in housing starts has been swift and deep. This decline has a trajectory much worse than the 1980's housing decline. Note that home sales do not add to GDP, but housing starts does affect growth rates.

The expectations should be that the Fed will have to add more liquidity and the impact on the real economy has yet to be seen.

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