4 Responses

1. James Says:
   November 22nd, 2006 at 10:42 am

   Thanks for the reply re ECRI. I have a different take, after exchanging emails with their research director. First, one must understand how ECRI forecasts and their models. The WLI is built to forecast the next 2-3 calendar quarters. Also, the “cheap” service that most individuals subscribe to only gets a small piece of the puzzle and at a lag. Their institutional clients pay $50k plus to get the data real time. I try to accumulate media snippets to get more timely info from them. They recently said that the WLI is showing a pervasive uptick. It is not yet prolonged or pronounced but it surely means that a recession is not in the cards through June 2007. In addition, they are now officially calling a cyclical peak in the inflation cycle.

   They indicators are contextual and based more on growth rates rather than absolute levels. Comparing their index to stocks in a linear fashion is apples/oranges. In my email exchange, I raised the issue of massive liquidity being created at the same time the FIG turning down. They replied that the FIG measures CPI inflation - not asset inflation. Essentially, if credit creation continues at it current pace, then asset prices could continue higher. I asked for clarification as to how this compares with 1999/2000, and they pointed out that the money supply did not plunge until AFTER the FIG peaked and a full year before the 2001 recession.

   Personally, I believe we are at a critical state (in the chaos theory sense), but that as long as the massive leverage in the system continues to expand prices could head higher. Monitoring the Yen exchange rate (Japan is the epicenter of global leverage) and money supply figures should give a warning sign on the economy. Of course, we the money supply data will be coincident with a stock decline, so that leaves the Yen….which is spiking big time today.

2. James Says:
   November 22nd, 2006 at 11:37 am

   http://globaleconomicanalysis.blogspot.com/2006/11/open-market-operations-interest-rates.html

   This is a good synopsis of how the Fed is largely irrelevant and how aggregate risk appetite is really what is in control.

3. reality Says:
   November 22nd, 2006 at 12:53 pm

   Well I am certainly prepared to believe that we are at (or beyond) a cyclical top in CPI inflation and in fact am trading that way. I just bought long bonds for just this reason, I believe that both interest rates and CPI inflation will be declining from here for the next couple of years at least.

   While accepting what you say about ECRI\’s model, I still have trouble with the forecast, given what is going on in the real estate market. How can credit creation \”continue at the present pace\” without the massive increases in mortgage debt that define the present pace - or more accurately the recent historical pace? This debt has been collateralized by rising property prices (worldwide). Where does the collateral (for more new credit) come from without rising property prices? This is not a rhetorical question - if you have an answer I would love to hear it because it is the crucial question, in my view.

4. James Says:
   November 22nd, 2006 at 1:13 pm

   I can offer my opinion based on what I know. The OCC has issued guidelines for the banks to tighten up lending in the real estate market…which they have promptly ignored. Collateral is a critically important variable in asset backed lending, but too bad our banking sector is largely ignoring it.

   Here is what I see happening. Borrowers and lendors are still largely in denial about what is happening. Lendors have quarterly numbers to make and the yield curve inversion is crushing their spreads. To make up for this major problem, they are reducing credit standards EVEN MORE to spike volumes. Mortgage apps support this, as they have been relatively stable given what is occuring with home prices. There is some evidence that borrowers are losing some appetite, but that is largely on the margins.

   In addition, the real bubble in this scheme has been behind the scenes in the CDO market. Banks are lending aggressively to hedge funds, who are turning around and leveraging up to buy the CDO’s from the Banks who package them. The velocity in money is exploding outside of the control of the Fed due to the wholey unregulated derivatives market.

   So in summary, what I see is lax credit standards preventing the mortgage bubble from popping for now, though consumer spending is likely to continue to lag and home price continue to drop. The massive creation of credit by banks via private equity, hedge funds and share buybacks could continue to drive securities markets higher…until something stops the cycle. Perhaps it will be the Yen or the long expected financial accident by a large player? Who knows? Eventually, critical things like collateral, long term fundamentals and valuations will matter, but they can all be ignored as long as noone is willing to take the punch bowl away.

   By the way, Europe’s monetary creation is spiralling faster than ours and outside of the UK their housing markets are behind ours by a couple of years. If this truly is a global liquidity bubble, then there could be more to come before the inevitable reckoning finally arrives. I enjoy the exchange…