While The Goin' is Good...
By: Jared Frost, 15 Mar 2022
1. The Fed is Changing Course
2. Denver Demand: The Usual Insanity
3. Denver Supply: Some Hope? Maybe...? Haha, Nah.
Welp, it's been quite a month since we last checked in with each other. War broke out in Europe, crude oil went to $130 and back, the S&P 500 is extremely volatile, and real estate prices are going berserk. The recent change in tone of negotiations between Russia & Ukraine is encouraging because the literal nuclear option is coming off the table. Regardless of how that war is resolved, major enemies still remain at the gates of domestic monetary policy-makers and those are the issues with which we now need to contend. The Fed is putting everyone on notice that rates are going up, so get your easy money while the goin' is still good...
The Fed is Changing Course
The war in Ukraine is obviously distracting investors right now. Further escalation presents additional geopolitical risks forcing massive realignments of global trade, supply chains, banking, etc; the best thing for all markets is a quick resolution that maintains the pre-war status quo as much as possible. Even so, this war forced everyone to pick a side that is accelerating the rise of new diplomatic tensions. How would you feel about trading oil in yuan instead of US Dollars? As an American in finance, that's a pretty scary thought, and now it's something that has a material probability of occurring. But, we can worry about those worries another day... The Fed is talking, and we need to pay attention.
The Fed does not take shifting lightly -- there's even an adage within investment circles that the Fed will go further and longer than you expect. That means when the Fed loosens (prints money, lowers rates, etc.), things are actually probably worse than you think and rates need to be lower or more money printed than you think is necessary based on the information available to you. Conversely, whenever the Fed ever tightens, they will likely go further and longer in that direction. This is a double-edged sword -- things are so great the Fed expects we can tolerate way more intense treatment for our inflation problem... And, they just started the tightening cycle this week.
Leading up to the Russia-Ukraine War, markets had been expecting a short-term rate hike from the Fed on the order of 50-75 basis points (0.5-0.75%), and those expectations came down heading into the meeting this week. So, it wasn't a big surprise when the Fed raised rates by 0.25% at this meeting. The important language in their announcement had to relate to their balance sheet, which has now grown to nearly $9 TRILLION DOLLARS. That's right, the Fed has monetized 30% of our total national debt. The most important language from their statement regarding their balance sheet is the following:
".. the Committee expects to begin reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities at a coming meeting."
While not entirely unexpected, it's an earth-shattering sentence. If you're curious why that's such a big deal, I submit the following chart:
Image taken from: https://www.currentmarketvaluation.com/posts/2021/07/Fed-Balance-Sheet-vs-SP500.php
Since the Fed started buying assets in 2008, they've expanded their balance sheet by $9 trillion. Over that time, the total market cap for the S&P 500 has grown by approximately $25 trillion. The picture above shows in the pictorial form how important monetization of debt has been to the equity markets. The relationship between Fed asset purchases and higher equity prices is even more obvious once put in context with data suggesting 40% of the market's growth can be attributed to printing money. It's a big problem for equity market investors when the Fed stops buying assets and it's an even bigger problem when the Fed says they are going to start reducing the balance sheet. The physics of money doesn't change so quickly as to assume these relationships will all of a sudden reverse. If the Fed is going to be raising rates on the short-end of the curve as well as decreasing balance sheet, the capital markets are going to be in for a wild ride. (Here's a fun little article on what happened when the Fed tried to decrease the balance sheet the first time...)
The Fed is telling us that rates are going up and things are going to get a little choppy. If you can get long-term, fixed-rate financing right now, do it.
Denver Demand: The Usual Insanity
Let's check in on our trusty table summarizing the residential market's activity in the area surrounding Union Station (10-mile radius) in Downtown Denver as of the end of February:
Data taken from REColorado on March 10, 2022
We look at demand primarily through pending and sold activity. As you can see from those two columns, the data has been extremely volatile over the last couple of years. Even though both metrics are down slightly in the past month, they are not down nearly as much as the supply metrics. The fact that the number of sold units has stayed relatively constant over the last few years is incredible. So many people have moved here with cash that the local demand curve is as close to "perfectly inelastic" (buyers are totally insensitive to price) as the real world will allow.
The price of a median unit in Denver, or the weighted average of home and condo prices, was around $625,000 last month. That means that the median Denver household is just barely not able to afford the monthly mortgage payments on a 20% downpayment loan if they even had the $125k to start. Given the lack of supply, the only thing that will put guardrails on the housing market is affordability (@Megan_Aller, where you at?) When rates go up and buyers have to offer lower prices to maintain debt-service ratios, that's the only thing that will get demand to go down, and we're not even close to that, yet.
Denver Supply: Some Hope? Maybe...? Haha, Nah.
I'm trying to move to Parker right now and one of our amazing brokers is helping me out, so I'm in the same boat as many of our clients. (Hey, if you know anyone in Parker looking to sell a house, give me a call.) Over the weekend, I got one of the email listing updates and saw about a dozen homes hit the market when I'm used to seeing one if I'm lucky. It was so exciting and I was convinced the market was shifting to finally get homes on the market. Yeah, that didn't happen, at all.
You might be seeing more homes come on the market and that's not unusual. Denver and the Front Range are extremely seasonal markets in that a majority of people want to move in the summer and not deal with real estate during ski season. The market typically starts to "wake up" around the end of March or the beginning of April, so it's not uncommon to see more listings come through right now than what you've seen recently. The problem is that we are seeing more than 40% fewer listings on the market from last year and that was a huge down year, too!
Here's some perspective for you... A comparison of supply metrics for 2022 vs. 2019 at the end of February:
Active Listings: 729 vs. 2,789 (-74%)
New Listings: 1,862 vs. 2,152 (-13%)
There are 74% fewer homes on the market now than there were three years ago!! That's crazy! If you want to take the data back to 2013, there are now 87% fewer listings on the market. On the demand side, sold activity is only down 2% from 2019 levels.
That's the ball game: demand is "down" 2% while supply is down 74%. Prices go up. And they'll go up until rates cool everything down.