Wednesday, January 03, 2007
Whew! what difference a few minutes make. In the span of 15 minutes today, the Dow Jones went from up nearly 100 points to down 40 points. The reason is our old friends real estate and inflation. When the much-awaited minutes of the Fed's December 12 meeting were released today, investors found a lump of coal, actually two lumps in their stockings. Housing was described as having substantially cooled (read Cold) and core inflation was described as remaining persistently higher than desired. Sounds like one of those conundrum things again, doesn't it? If housing is falling off the table, the Fed would like to be cutting rates sooner rather than later, but if Core CPI is still too hot for comfort that would seem to preclude the "sooner rather than later" strategy. I believe this is a false conundrum because the worries over inflation will subside soon. Here's my reasoning: I believe housing is weaker than most people think(see previous post). Housing prices have fallen in two of the last three reports, and they are likely to fall farther. Having said this, housing almost by itself can cure the problem of the Core CPI. The reason: it receives nearly 40% of the weighting of the Core index. Thus for every one percent fall in housing prices, we should get nearly .4% percent fall in Core CPI. In this way, Core CPI should fall sharply in the coming months and move off the Fed's radar screen. In my judgment, that leaves us with one lump of coal -- housing. I have grown progressively more bearish on the soft landing in housing as I said my December 11, post. I believe there is more pain coming in housing and it will also manifest itself in slower overall economic growth in 2007 than the consensus estimates. The housing issue is not all bad news for the economy, however, I'll have more to say on that in the coming days.