So, the reality is that based on our modeling system and our research, there are only two ways that the US Fed (and likely the global central banks) can navigate out of this inflation killing debt glut that has sunk the global markets into a quicksand-like economic malaise; either A. reduce debts dramatically across the board (all nations) in an attempt to allow for some level of future growth/inflation opportunity, or B. find a way to push GDP out levels to 2x (or higher) that of current debt levels. A is much more difficult to negotiate and navigate – but it may be an option sometime in the future. B is the more likely option with a transition into some type of new 21st-century economic model that assists in advancing the build-it, sell-it model.
In the last, Part II, a section of our research, we showed you a chart of our US Fed modeling system and where we believe the US Fed should be targeting rates currently. The one thing that was a bit different than our original model, created in 2013, was the election of President Trump and the EU, US/China trade wars. This could complicate things a bit in the future, but overall the model continues to perform well.
Our research suggests that given current global market factors, we are looking at a very narrow pricing structure for US fed rates that are completely dependent on consumer activities (consumer optimism and activity, perception of the economic opportunities and supply/demand price equilibrium). Which is why we believe the next 15+ months could be very interesting for global traders and consumers.
We use a simple tool to track the levels and scope of the changing markets in various areas of the US and have noticed a dramatic increase in the numbers of Foreclosures and Pre-Foreclosures in various prime markets over the past 12+ months. Take a look at some of these maps.
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In each one of these maps, there are more than 500+ current active Foreclosures and/or Pre-Foreclosure listing. These are prime real estate areas like Los Angeles/Hollywood, CA, New York City, NY, San Francisco, CA, Phoenix, AZ, Chicago, IL and Newark, NJ. Either the market is changing or the consumer is changing because affordability is sky-high.
The law of supply and demand dictates that when the price gets too high and affordability is beyond the scope of the average buyer, then price MUST fall to levels that support healthy buyers and re-balance the marketplace. This type of price reversion has happened many times in the past, but this time we believe the US Fed may just let the dust settle and allow these foreclosures to funnel through the traditional channels (banks and financial institutions.
We do believe the US Fed is slightly behind the curve in terms of rate levels and actions. The Fed waited till 2016 to begin raising rates when our model suggested rates should have been raised in 2013. Additionally, the Fed raised rates above the 2.25% upper boundary of our modeling system. The Fed recently began to decrease rates from the 2.5% level which we agree with. The Fed target should be between 1.5% to 2.0% at this point and levels should fluctuate up and down within this range for the next 4+ years – gradually settling near 1.25% near 2024.
Again, there are only two outcomes that can dramatically alter the path without our modeling system – dramatic debt reduction or dramatic GDP increases. Possibly, we may see a combination of both of these over the next 10+ years, but our belief is that the US Fed is trapped in a low growth, mild inflationary mode waiting for GDP to increase while attempt to PRAY that no asset bubble pops. The reality is that bubble will pop and price levels will revert to find “true value” before any real GDP increases begin to take form.
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In Part I of this research, we highlighted the Case-Shiller index of home affordability and how it relates to the US real estate market and consumer economic activity going forward. We warned that once consumers start to shift away from an optimistic view of the economy, they typically shift into a protectionist stance where they attempt to protect wealth, assets and risk of loss while attempting to weather the economic storm.
We’ve seen this happen in 2008-09 as well as after the 9/11 attacks in the US in 2001. The process is always somewhat similar. Consumers start to react to pricing levels that are unaffordable and do so by trying to skimp on extraneous purchases like travel, new cars, credit card debt or other items that are not essential. The other thing that happens is that the lower tier borrowers (the “at-risk borrowers”) typically begin to become delinquent on debts and fall behind on their mortgage payments. This is how the process starts.
Once it starts, a shift takes place in the market that can be sudden or it can be transitional. The shift is often termed as a change from a “Seller’s Market” to a “Buyer’s Market”. This terminology is used to describe who is in control of the transaction and who has the advantage within the transaction. When it is a “Seller’s Market”, buyers are typically offering to pay MORE for an item/home and the seller does not have to stress about trying to sell their property/items. When it is a “Buyer’s Market”, the buyer is able to negotiate with the seller, demanding more concessions, lower prices, better deals and often has a wide variety of sellers wanting to court the buyer away from other property/items. See how this shift in market dynamics can really change the way a marketplace works.
Now, lets take a look at how the US consumer is doing, overall, and how it might reflect a change in the marketplace if certain fundamental change.
This chart of the delinquency rates for All Loans and Leases in the US shows an increase in the levels of delinquencies starting near the 2016 year. This aligns with the year that the US Fed began raising the Fed Funds Rate and is exactly 1 year after the Chinese initiated capital controls to attempt to prevent local currency (Chinese Yuan) from leaving the country and landing in other countries as foreign assets. In 2015, the delinquency rate for All Loans and Leases was near 2004~05 levels (below 30,000). Right now, the level is above the 2008 level near 36,000.
Consumer Credit Card Delinquencies are rising sharply. Since 2016, the increase in sub-prime credit card delinquencies has skyrocketed above the peak levels of 2008-09 and continues to stay above 5.5%.
Meanwhile, those nasty Mortgage Backed Securities held outright are still massively higher than in 2008/09 based on this Fred data. We are unsure why the data is reported as ZERO in 2008, but we can safely assume that a $1.55 Trillion risk factor in these MBS levels is not something that we would consider a minor risk factor.
Now, in the first part of this article, we promised to show you some data from our proprietary Fed modeling utility and to show you what we use to determine if the US Fed is ahead of the curve or behind it. Here you go..
Our original research model of the US economy and the Fed Rate levels into the future are shown below. You can see that our model suggests the US Fed, as of 2013, should have been raising rates towards the 1.5% level then gradually raising them further towards 2.0% to 2.25% before 2017. This type of increase would have slowed the advance of the real estate price levels and moderated the expansion of the debt levels that are currently associated within this sector. Instead, the US Fed was late in their efforts to raise rates – starting only in late 2016.