A peak forming in realized rents?
Peaky effective inflation, a CPI peak in 2Q, and derivative (crypto) musings
Zillow’s January data shows the first clear evidence, IMO, of a short-term peak in rents.
Zillow seems to have altered their ZORI (Observed Rent Index) methodology a bit—they no longer report the raw data, which I’d used in these posts before, and only report the smoothed/seasonally-adjusted data now. So the below numbers have a small comparability issue with the ones I’ve posted previously, but this data should show the annual trends just as clearly as what I’ve posted previously.
Nationwide, the smoothed, seasonally-adjusted, population-weighted rental comp is topping out around 15%.
Big blue cities:
Monthly nationwide rent comps under Zillow’s revised methodology:
This is the second time in 3 months that the comp has decelerated, and the 2 year stack has also decelerated.
cracks showing in the hypergrowth MSAs printing 30%+ comps over the past 12 months,
the key driver of hypergrowth MSAs (blue-to-red migration) ending,
cracks also showing up in the large blue laggards,
realized rent comps getting much tougher starting in April 2022,
the near-certain end of Fed support for the mortgage market, now that CPI has become such an embarrassment,
the massive move higher in longer duration mortgage yields in late January/Feb, and
a pretty big glut of new housing permits (TX and FL new home permits are now very close to 2005-6 highs, for example) relative to recent volatility,
… I feel comfortable calling a short-term top in realized rent inflation here.
CPI prints will still see aggressive upward pressure from rents for the next 6 months. Even if commodities prices gradually dropped in a straight line starting today, and rents didn’t increase any further, BLS-reported CPI wouldn’t peak until mid-2Q.
Commodities, supply chains, &c
Commodity indices (example) are maintaining +30%ish y/y prints in the face of extremely tough comps. Commodities comps and shipping cost comps get much more difficult as we go through the year.
None of this is news to anybody paying attention. The Fed/FinTwit ‘inflation has obviously peaked’ consensus in November was based on a facile combination of looking at comps over the next 12 months and a feeling that inflation seemed pretty high then.
Of course, going from 11% effective inflation to 5-7% effective inflation by 2H22 amidst near-zero rates and 3-5% salary increases is still a quality-of-life disaster, and the Fed’s largest failure in history. I didn’t think this was a credible scenario until realized rents finally cracked. Of course, rents haven’t cracked yet, but we can at least sketch out a plausible base case of them cracking.
If rents are still up double digits by the summer, consumers will face a severe tax increase in the form of the majority of rents rolling over, as our private-equity feudal landlords monetize Fed-sponsored asset price inflation via ratcheting rents up.
Crypto in a falling-CPI context
I’m a fundamental analyst, so I think a lot (way too much) about necessary preconditions for top-tier cryptoassets to return to their pedestal of “excellent inflation protection plus high-octane risk asset.” What risk characteristics would make top crypto-assets attractive to own again?
Low reflexivity risk (troughed on-chain money velocity)
Cryptocurrencies without real-world income-generating asset linkage will fall into insanely reflexive earnings spirals during broad macro downturns: ETH has the same P/E that it had in December, after dropping almost 50%!
A cryptocurrency will have no fundamental valuation support (protocol revenues garnished by token-holders) until network velocity stops dropping faster than asset prices (until intrinsic demand in the crypto-economy is able to leverage lower gas fees to make velocity pick up naturally).
A ratio like protocol market cap (USD) to trailing 7-day protocol daily transaction value (USD) strikes me as a good metric by which to assess this risk. By that measure, ETH is overvalued in the short term.
Similarly, a dropping short-term P/E in the face of dropping prices would indicate that velocity dropped much less than asset prices fell. dYdX for example has seen a 50% de-rating in its pro forma earnings multiple over the past month.
Volatility calming down in the long-duration-asset complex
Cryptocurrency is the fusion of software and payments, plus an extremely cyclical store-of-value factor. So it makes sense for crypto to trade like software or payments stocks, along with a highly cyclical store-of-value premium and a cyclical market share premium (crypto gains share during risk-on and loses it during risk-off). Which, in turn, should trade with long-dated Treasuries.
Light at the end of the CPI/rates tunnel
Closely related to calming bond volatility is a lower momentum of surprise in monthly CPI prints. The CPI surprises are destroying Fed credibility and increasing political pressure on the Fed to tighten early
I turned short-term-bearish on crypto-assets before the January CPI print (Feb. 7-9) because I felt like the market was under-pricing the risk of greater Fed unpredictability in light of bad CPIs and heavier subsequent political pressure on the Fed to tighten faster.
I feel like the short-long-duration trade is mostly played out:
the Fed and rates are all non-fixed-income specialists in CT talks about now, including yours truly, ie it’s at peak fear;
US bonds seem like an inevitable refuge from European bonds which have much more volatility potentially in store in a global super-tightening cycle;
Japan committed to buying “unlimited amounts of bonds” after a failed bond auction early last week, which will push Japanese bond investors into overseas bonds i.e. the US;
China has started a credit easing cycle, which should be marginally supportive of foreign fixed income
Asian PPI’s have been falling for 2-3 months. Another 2-3 months of them falling, and it will be more confirmation that consumer inflation has peaked
Equity volatility calming down
The VIX futures curve is backwardated. When front month futures are significantly backwardated vs later month futures, that’s a well-known buy signal (if you don’t use leverage). When the VIX futures curve is modestly backwardated (as now), the signal is that while fear is indeed high, there’s still a large potential for short-term drawdowns in risk assets.
Vol futures are currently 4% backwardated (front month vs 2nd month). That’s actually not a great time to be long equities.
A steeper (in this environment) yield curve
The 2/10 yield spread is around 50bps today. It actually is not that accurate for forecasting recessions, but it does clearly indicate the remaining amount of ‘gas in the tank’ for an economic expansion.
Normally, a flat yield curve is bullish for crypto-assets because it means the Fed will lower overnight rates to re-steepen the yield curve, thus further mortgaging the future to prolong a present expansion as they usually do. However, because short rates are already zero, there’s no room to do that without cutting overnight rates below zero (and probably sparking a run on the fiat banking system). And lowering rates in general is indefensible with CPI where it is today.
That was the presumed inspiration for Zoltan Poszar, a former high-ranking official at Treasury and the NY Fed, to write his thought bomb last week that the Fed might prefer, for the first time in living memory, to “bear steepen” the curve (rates go up, long rates up the most) by dumping long-duration assets, as opposed to “bull steepen” (rates go down or stay flat, short rates go down the most) the curve.
Thus far, the Fed has forcefully pushed back on that view in on-background interviews with Bloomberg/WSJ.
But the political pressure on the Fed is spiraling.
The DC Republicans who will be increasingly calling the shots for the next 6 years (2023-24 will be a lame duck presidency with likely Republican majorities in both houses + DC Democrats shuffling off into the private sector) would be much happier to have the Fed spur a stagflationary recession on Biden’s watch, as opposed to their own.
Biden has already laid the responsibility for fighting inflation at the Fed’s feet.
The NY Fed’s John Williams made this cycle’s first reference to a ‘soft landing’ on Friday. The Fed has a very wide dispersion of views which will get worse with more CPI surprises.
The GOP has very unusual leverage over the Fed now (particularly over Powell and Brainard) because of unrelated confirmation politics.
The Goldilocks scenario for crypto is some combination of declining Fed credibility (hard to imagine, as it’s already so low), falling CPI (very likely in 3 months, but not today), stabilized or falling nominal bond yields (very possibly here), rising real incomes / rising cash reserves at US commercial banks (real incomes have been falling, and cash reserves have basically stopped growing, although the backlog remains massive), and depressed on-network money velocity (we’re definitely not there yet).
In my experience and study, backwardation >8% is a rare, high conviction buy signal (if you’re unleveraged and willing to take large short-term drawdowns). At the Covid bottom in March 2020, the curve was 20% backwardated. At the bankruptcy of Lehman Brothers, the curve was something like 30% backwardated, IIRC.
Backwardation at ~4% carries a high risk of getting worse before it gets better. The greatest threat of a severe drawdown is when VIX futures are modestly backwardated, as they are today.
Jerome Powell and Lael Brainard are both unconfirmed because Republicans rejected a separate Biden Fed nomination (Sarah Bloom Raskin) as corrupt and conflicted (and they won’t yield on it).
Great writing and thoughts, as usual. Thanks!