June rent internals: the 2y stacked comp accelerates again
When will the Fed nuke the MBS market?
Zillow’s June data dump is a continuation of recent themes. Rental inflation is declining year-over-year from easing comps, but the 2-year stack continues to accelerate. Officially-measured inflation — 30% of CPI and 40% of core CPI — will march higher until the orange and blue lines on this chart cross.
I would normally do the decile-by-decile chartporn but there’s very little new content there relative to the last update.
The 2-year stack made a new high in June, +21%.
The fact that we are still showing a 2y stack acceleration heading into the biggest rent-renewal months is a big surprise to me. If the 1,000 Fed economist PhDs actually knew what they were doing, they would weight rental inflation much more heavily in May-August, because that’s when most annual rent contracts roll over, so realized rental CPI for the next 12 months in this category is pretty much set in stone by what’s happening now.
I had predicted in April, based on data thru March, that we’d see a clear negative inflection in these numbers by 3Q. That has to be pushed out to 4Q now.
Which is a huge problem for anybody who thinks the Fed rate cycle is going to end after 1 or 2 more hikes.
The Fed’s political incentives
The Fed is first and foremost a political institution. The political impact of inflation has swamped a 6-month, 35% Nasdaq drawdown, not to mention the mother of all political third rails (SCOTUS tossing Roe v. Wade). It’s also turned Hispanics into the most Republican mega-demo in the US.
The Fed’s institutional mandates, in order of current priority, are
(if CPI is high, lower CPI | if CPI is low, “refill the punch bowl” to maximize aura of FOMC competence & speaking fees, and fatten the trough for other political and economic players)
shorthand: min(CPI) to max(Cantillon effect total value transfer)
manage rates / regulations / capital requirements such that US banks can consistently make profits
manage interest rates relative to other countries’ rates such that the USD isn’t too strong for too long (whatever that means)
acting as a borrowing facilitator for the US Treasury
Because of how bad CPI is, and because IRL inflation is at least 4 points higher than official CPI, inflation has mostly solved DC’s short-term deficit problem as a large tax increase on the working class.
The Fed’s low rates have financed a completely unhinged level of federal spending by both parties since 2016. The Pelosi-McConnell uniparty is still torn between way more federal spending or just somewhat more federal spending. “Unsustainably” high rates on a still high but not insane level of deficit spending is the only imaginable brake on federal spending.
The Fed will keep raising rates until a) polls say people are more worried about the economy than inflation; b) core CPI drops below 3% from the current 6% (not possible with rent inflation doing what it’s doing); or c) a recession severe enough to knock CPI flat on its back is obviously imminent.
Everyone agrees that the Fed has an impossible job. But what’s the path of least resistance to the Fed making the best of an impossible job?
Operation MBS Runoff?
As the ECB starts to play catch-up on rates, a very deflationary force, the strength of the USD, will lose its teeth.
A Russia-Ukraine cease-fire probably won’t help inflation either (at least not in the US). Russian oil is laundered onto the global market via India. Ukrainian grain is being requisitioned and sold by Russia as well.
The rise in mortgage rates, while it has cooled US homebuilding activity, has only started to make a dent in housing inventory levels; we’d several more months of deep slowdown to reach the “healthy inventory levels” of 2017-2019.
The easiest path for most-effective, least-painful-to-society Fed tightening is for the Fed to rebalance its balance sheet to *not* run off Treasuries, while at the same time actively liquidating its MBS portfolio (as opposed to running it off). Which would be a disaster for risk assets, but would make life comparatively easy for the US government while cratering US rent inflation (which, remember, is 40% of core CPI) as quickly as possible.
Great analysis. Appreciate that you've taken the time to write and share your thoughts.
Howard Marks said he thought agency MBS bonds were now offering very attractive risk/reward returns. I spent the morning considering VMBS (ETF), but I'm just not seeing the relative attractiveness to non-callable UST.
If you have a moment, mind commenting on current agency MBS as an investment? Do you know of a source that publishes OAS for agency MBS?
Can you ELI5 why the Fed liquidating its MBS portfolio would be a disaster for risk assets?