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Five Things You Need to Know: The Plot Thickens, Homeowner Theory of Relativity, Personal Savings Looting Continues, 65% Club, Department of Impossible to Make Up: Rising Gas Prices Cripple Home Sales

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What you need to know (and what it means)!

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Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. The Plot Thickens

Core consumer prices, which exclude food and energy, rose 0.2% in October, matching September's rise but slightly higher than the expected 0.1%, the Bureau of Economic Analysis reported this morning.

  • On a year-over-year basis, the core PCE Deflator was up 2.4 percent, the same increase as in September.
  • The Fed considers the core PCE deflator its preferred inflation measure.
  • How do we know this? Because the changeover from using the Consumer Price Index as the Fed's preferred inflation measure to using the PCE Deflator was explicitly outlined by then-Fed Chairman Alan Greenspan in his Humphrey Hawkins testimony in February 2000.
  • What exactly is this so-called "PCE Deflator" and how does it differ from the Consumer Price Index?
  • The difference between the PCE Deflator and the CPI is that the PCE Deflator finds the average increase in prices for all domestic personal consumption as opposed to a fixed basket of goods.
  • That's econo-speak, and sounds petty, but it's actually a pretty big difference. The CPI, by focusing on a fixed basket of goods, assumes consumers make no changes in their spending habits.
  • The PCE Deflator measures inflation based on changes in personal consumption. For example, if price changes prompt us to substitute one good for another.
  • In a speech on Tuesday Fed Chairman Ben Bernanke said "inflation remains uncomfortably high." But to support this scary claim he cited the Consumer Price Index.
  • "Core CPI inflation over the most recent twelve months was 2.7 percent, up from 2.1 percent over the previous twelve months," Bernanke said.
  • The subtext is that if inflation is indeed "uncomfortably high," then the Fed may be forced to act to quash it by raising rates.
  • Sounds good. Dollar strong. Hawkish. Upbeat and positive.
  • However, when we look back at Bernanke's Senate Banking testimony this past July, we see that in reality, the core PCE Deflator (which it suited him to talk about at that time) is exactly where the Fed figured it might be.
  • "As measured by the price index for personal consumption expenditures excluding food and energy," he noted, "inflation is projected to be 2-1/4 percent to 2-1/2 percent this year and then to edge lower, to 2 percent to 2-1/4 percent next year."
  • So why the scary talk? Perhaps it's all they have left.

2. Homeowner Theory of Relativity

Are interest rates too low? Too high? About right? Good question. The answer is a bit like E=MC2.

  • What does it mean for interest rates to be too low? Too low compared to what?
  • Well, compared to, say, 1976, interest rates look low.
  • A conventional mortgage in the mid 70s was running around 9%.
  • Today a conventional 30-year fixed rate mortgage is 6.13%, according to the Mortgage Bankers Association Weekly Mortgage Applications Survey.
  • But the absolute level of interest rates tells us very little about what is happening, especially when it comes to mortgages.
  • For example, when someone at, say, the National Association of Realtors trumpets "historically low" mortgage rates in isolation it tells us almost nothing about the actual "cheapness" of mortgages.
  • Freddie Mac tracks the ratio of what homeowners who face mortgage resets and refinancings are "rolling into" divided by what they are rolling out of, which actually gives us a bit of "context" for interest rates.
  • According to Freddie Mac data, which Merrill Lynch's David Rosenberg recently looked at, this ratio has steadily increased this year.
  • A ratio higher than 1 means that homeowners' debt burden is increasing.
  • In the first quarter the ratio was 1.02. It rose to 1.08 in the second quarter.
  • This ratio has risen to 1.22 in the third quarter, a record high.
  • So yes, interest rates are historically low in an absolute sense, but debt burdens are rising, and the important factor is not how absolutely low mortgage rates may be but how consumers manage their debt burden as interest rates show a relative increase.

3. Personal Savings Looting Continues

Speaking of debt burdens, take a look at Personal Savings reported this morning by the Bureau of Economic Analysis.

  • Personal Savings "improved" to negative 0.6% in October from negative 0.7% in September....
  • ... which means consumers are having to loot slightly less of their personal savings than they were last month to afford the lavish lifestyle of the comfortably-housed and well-dressed poor.
  • The Personal Savings rate has been negative now for 19 straight months.
  • One day in the future consumer balance sheet repair will really begin.
  • Until then, carry on. Risk ain't nothing but a thing.

4. 65% Club

The Bank of Japan gave its first-ever breakdown of its foreign-currency assets Wednesday, reporting that dollar-denominated assets accounted for about 65% as of Sept. 30, Nikkei Net reported.

  • Total foreign-currency assets totaled 5.23 trillion yen, according to the Bank of Japan.
  • Euro-denominated assets accounted for 30% of the total.
  • Pounds accounted for about 5%.
  • According to the International Monetary Fund, as of June 30 the dollar accounted for about 65% of the foreign reserves at central banks around the world.
  • Meanwhile, the dollar this morning hit a 14-year low against the pound and a new 2-month low against the euro.
  • The dollar is also lower versus the yen, but as MacroMavens' Stephanie Pomboy noted on the Buzz & Banter yesterday, has yet to shake carry traders from their roost.
  • "The ability to borrow in cheap currencies like the yen and swissie continues to be an important force in the global liquidity dynamic," she noted.

5. Department of Impossible to Make Up: Rising Gas Prices Cripple Home Sales

Minyan Eric in Colorado was kind enough to forward us the following "impossible to make up" nugget from a Denver-area newspaper this morning.

  • "There are fresh indications the housing market has grown more sluggish in metropolitan Denver and parts of Weld County, new reports show," the article notes ominously.
  • How do they know? "One indication is declining sales. In the first nine months of the year, new-home sales in metropolitan Denver dropped nearly 20 percent and existing-home sales were down 9.5 percent from a comparable period in 2005, according to the Genesis Group, a real estate consulting firm."
  • Oh, declining sales. That's how they know.
  • But what could be causing these declining sales?
  • Real estate agents blame the usual suspects, the article notes; aggressive lending practices that have resulted in foreclosures, rising interest rates (but hey, the NAR says interest rates are at historic lows!) and other economic factors.
  • What other economic factors?
  • "Other economic factors weighing on the pocketbook such as gasoline prices."
  • Interesting thought there: that if you can't afford to buy gas, you can't afford to buy a house. Hadn't really thought about that.
  • One solution to declining home sales based on high gas prices: The Mobile Home.

    Killing two birds with one stone.
    (Did we mention it's a Mercedes?)

No positions in stocks mentioned.

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