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Tightening supply and ZERO rates help stoke the inflation fire for Q4…

July housing starts fell to an annualized rate of 581,000 units, from an upwardly revised 587,000 units in June and below the median expectation of 600,000 units; the July decline was due to a 13.3% drop in multi-family homes. 

(continued discussion post charts)

US Housing: Reflation's Rotation - a1

THE GOOD NEWS - The all important single family housing starts rose 1.7% in July to 490,000 units. The 14.0% gain in the Northeast was the driving force behind the growth in single family starts. 

THE BAD NEWS – There is a housing supply imbalance building.  The chart below provides a clear picture of the true supply of housing in the United States – the number of houses started minus the number of houses completed.

US Housing: Reflation's Rotation - a2

Since 1979 there are three pronounced periods where we see a real reduction in the true supply of new homes being built; 1, 1 and the current housing crisis.  While there are numerous nuances to each time period, each one was followed by a significant increase in inflation.  Intuitively it makes sense that during recessionary periods supply tightening will occur when producers overestimate demand declines, and that the resulting imbalance can create inflationary pressure (particularly if combined with low rates). In the chart below, we have mapped out this ratio against PPI. Note that historically; cycles of declining Starts to Completions have troughed at the same time that inflation has peaked prior to the current cycle.

US Housing: Reflation's Rotation - a3

The reality is that the decline in home values, low interest rates, government incentives and the increase in household formations WILL create real demand for housing units.  As a result, there is a disconnect between the perceived demand that people are not buying houses right now and the real demand, creating a “real” decline in housing supply.  At some point this will lead to future issues – INFLATION.

This is not the sole impact of housing on reflation: after all it is the substantial decline in home prices that created a tidal wave of problems for the economy and our financial system.  This has allowed the FED to keep interest rates artificially low for an extended period and helped the Government to go on a debt fueled  spending spree, killing the value of our currency.  The currency crisis will ultimately lead to imported inflation. We’ve labeled this transition period, Reflation’s Rotation (Q3 prices moving from y/y deflation to Q4 y/y inflation).

THE CONSEQUENCES – We are not just looking for another data point that will help justify our Q4 “reflation rotation” theme, but things are looking more ominous for inflation to return in Q4. 

Howard Penney

Managing Director

Andrew barber