"The Fed Has Been Horribly Wrong" Deutsche Bank Admits, Dares To Ask If Yellen Is Planning A Housing Market Crash

Tyler Durden's picture

The reason why Zero Hedge has been steadfast over the past 6 years in its accusation that the Fed is making a mockery of, and destroying not only the very fabric of capital markets (something which Citigroup now openly admits almost every week) but the US economy itself (as Goldman most recently hinted last week when it lowered its long-term "potential GDP" growth of the US by 0.5% to 1.75%), is simple: all along we knew we have been right, and all the career economists, Wall Street weathermen-cum-strategists, and "straight to CNBC" book-talking pundits were wrong. Not to mention the Fed.

Indeed, the onus was not on us to prove how the Fed is wrong, but on the Fed - those smartest career academics in the room - to show it can grow the economy even as it has pushed global capital markets into a state of epic, bubble frenzy, with new all time highs a daily event across the globe, while the living standard of an ever increasing part of the world's middle-class deteriorates with every passing year. We merely point out the truth that the propaganda media was too compromised, too ashamed or to clueless to comprehend.

And now, 7 years after the start of the Fed's grand - and doomed - experiment, the flood of other "serious people", not finally admitting the "tinfoil, fringe blogs" were right all along, and the Fed was wrong, has finally been unleashed.

Here is Deutsche Bank admitting that not only the Fed is lying to the American people:

Truth be told, we think the Fed is obliged to talk up the economy because if they were brutally honest, the economy what vestiges of optimism remain in the domestic sectors could quickly evaporate.

But has been "horribly wrong" all along:

At issue is whether or not the Fed in particular but the market in general has properly understood the nature of the economic problem. The more we dig into this, the more we are afraid that they do not. So aside from a data revision tsunami, we would suggest that the Fed has the outlook not just horribly wrong, but completely misunderstood.

 

... the idea that the economy is “ready” for a removal of accommodation and that there is any sense in it from the perspective of rising inflation expectations and a stronger real growth outlook is nonsense

And the kicker: it is no longer some "tinfoil, fringe blog", but the bank with over €50 trillion in derivatives on its balance sheet itself which dares to hint that in order to make a housing-led recovery possible, the Fed itself is willing to crash the housing market!

... if the single objective was to reduce inflation, regardless of where it came from, then crashing the housing market is certainly one way of going about it.... The dilemma for the Fed is of course that it is precisely the decision not to crash the housing market by doing extraordinary stimulus in the first place that has led to the current outcome of weak ex housing demand and strong housing inflation. The decision is akin to embracing financial repression as an alternative to the uncertainty of asset price deflation and a debt default cycle. If we could reset house prices 30 percent lower and fast forward a few years, the economy would probably be meaningfully more dynamic but it is those few years that might be hairy and no one let alone the Fed would likely stomach the risks.

Here is the full note from Deutsche Bank which we expect every other primary dealer to copycat in the coming weeks and months now that the truth among the "very serious people" is finally out.

* * *

At issue is whether or not the Fed in particular but the market in general has properly understood the nature of the economic problem. The more we dig into this, the more we are afraid that they do not. So aside from a data revision tsunami, we would suggest that the Fed has the outlook not just horribly wrong, but completely misunderstood. And here’s why.

For many years we have focused on the poor supply side dynamics of US growth and more recently have recognized it as much a global phenomenon when it comes to productivity. And as we know supply always equals demand so invariably there is some “disappointment” in demand side metrics. What we haven’t dwelt on much is whether demand creates supply or, as in Say’s world, does supply create demand. It is very easy to see through the latter’s linkages. Companies have to meet a given demand say but choose to use cheap labor rather than invest for productivity. Productivity may be weaker for longer. Perhaps there is a lack of innovation so a lesser requirement to invest. Perhaps there’s greater depreciation so investment spend may be less impressive on a net basis. Since it takes a while for wages to pick up (need to be nearer full employment), demand doesn’t really strengthen much. Global issues may depress pricing, so this is an additional constraint for the investment outlook. But over time the hope is that under an accommodative monetary policy, full employment is reached, wages rise and companies are encouraged to substitute capital for labor thus boosting productivity and there is a virtuous cycle of rising demand, strengthening expected returns on investment so encouraging still stronger growth. It is not clear that pricing power returns but the profit cycle is supported nevertheless through higher productivity. Now it could be debated that this is just as much about demand driving supply in the sense of the investment cycle. At least though in the context of weak underlying demographics, initially sluggish associated demand plus the lack of innovation explaining weak investment and productivity, it can also be a supply led story.

However there is also a whole different demand side angle to this that is less to do with the wage-productivity nexus but more to do structural weak consumer demand and the hangover from the housing crisis. This of course will tie out to weaker productivity and therefore weaker wages as well. It starts with the recognition that since the crisis or at least a few years after the initial rebound, consumer demand is decidedly weaker than it was pre crisis. As we highlighted last weak using log real retail sales we can observe a distinct weakening in the post crisis trend, especially in the past couple of years that’s worth almost up to 1 percent. Taking a broader look at consumption, the weakness however is even more protracted in housing services and especially in owner occupied housing. The latter is particularly important because it is the germ of demand for other consumption. Owners typically will furnish their home, buy more “stuff”, maintain the property through other services more aggressively etc. than say tenants. The “multiplier” effects of home ownership are almost certainly stronger than for tenant homes, controlling for age etc. It is therefore concerning that while household formation may be rising, homeownerships rates are still falling.

What is then striking of course is that if housing consumption is unusually weak, why are housing components of inflation so strong? As the charts show it is quite striking that overall housing inflation in the PCE is almost 3 percent year over year (2.7 percent for owner occupied component) but for owner occupied housing consumption it is the most chronically divergent weaker than all other major consumption categories. Tenant home consumption is in line with trend despite also having a very strong deflator. Effectively we can think of housing as being in “stagflation”.

Of course the obvious conclusion is that it is precisely because owner occupied housing is expensive in absolute terms that there is limited consumption in absolute terms that drives rental consumption relatively higher with also higher rents. The imputed rental for owner occupied housing comes from an adjusted rental series for tenancies so the results are consistent i.e. expensive rents and owner occupied, trend consumption for tenant housing consumption and below trend for owner occupied. In turn this then spills over into below trend for consumption ex housing. Note that weak consumption ex housing then also implies weak inflation in those sectors.

The actual numbers are impressive. Owner occupied consumption in the PCE is almost half the trend since 2010 compared with the whole sample period 1990-2015q1. Annualized it is growing around 0.8 percent compared with over 2.5 percent for the whole period. It represents around 11 percent of total consumption, so alone shaves 0.1 to 0.15 percent off the trend realized real GDP growth. For the rest of consumption, including the other components of housing the trend is better but still disappointing since 2010. It drops from around 3 percent to 2.4 percent so in GDP terms effectively shaving 0.4 to 0.5 percent from trend GDP. Note that for tenant housing the trend is stronger, as we would expect but quite volatile. Currently running around 2.6 percent versus the whole sample trend of only 1.8 percent. However, interestingly recently the rental  trend seems to be a little weaker, suggesting high rents themselves are exerting a downward pressure on housing consumption.

There are other interesting observations to note. For example, goods PCE alone isn’t too far off trend but is a little lower, around 3.2 percent versus 3.6 percent for the whole sample, while healthcare consumption is bang on an unchanged trend.

The next charts show the housing and inflation ex housing deflators. Core CPI ex shelter is pretty much still at post crisis lows, less than 1 percent year over year. Consistent with the PCE analysis above, the PCE ex housing the deflator is zero. The deflator ex housing, ex energy is less than 1.2 percent year, but falling. The housing deflators, in line CPI housing and OER are close to 3 percent year over year.

This brings us to the crux of the analysis. If the inflation “problem” or risk is in housing but the weakness in demand also stems from housing, what on earth is the Fed, or anyone for that matter, thinking in terms of the logic for removing accommodation? The inflation problem is not being created by excess demand for housing i.e. a housing boom because that would show up in terms of excess demand for consumption ex housing. Instead it is the quirky result of owner occupied housing being too “expensive” relative to rental housing which pushes up overall housing inflation via rents.

Of course if the single objective was to reduce inflation, regardless of where it came from, then crashing the housing market is certainly one way of going about it; but it would only work if it forced homeowners to sell their homes and become renters, assuming house prices did actually fall in the process. Simply keeping house prices elevated and having new supply come onto the market even if it all goes into the rental sector won’t necessarily help if house prices are  lofty since rents may stay robust. This is effectively what has been going on anyway.

The dilemma for the Fed is of course that it is precisely the decision not to crash the housing market by doing extraordinary stimulus in the first place that has led to the current outcome of weak ex housing demand and strong housing inflation. The decision is akin to embracing financial repression as an alternative to the uncertainty of asset price deflation and a debt default cycle. If we could reset house prices 30 percent lower and fast forward a few years, the economy would probably be meaningfully more dynamic but it is those few years that might be hairy and no one let alone the Fed would likely stomach the risks.

The alternative is to accept elevated house prices as a byproduct of the stimulus and look to the supply side of housing to address high rents. If we consider housing completions as our supply of housing variable, it is clear that the only thing that really correlates with new supply is the change in the debt income ratio of the household sector. Balance sheet expansion is good for housing supply. Importantly, affordability doesn’t just have no relationship with, but if anything, is inversely correlated with supply. Housing affordability does not solicit new supply.

Higher house prices do solicit some new supply, although there is a very large gap now in that supply has been very slow to respond to higher prices. The real issue is that housing supply is linked to household balance sheet expansion- proxied by the change in the debt income ratio. Since this has been growing slowly, so has supply been slow to come back on tap.  Households are still feeling balance sheet constrained.

So that leaves two policy choices. One is to wait much longer for supply to catch up with elevated house prices but “hope” that prices don’t become further elevated. (We can give a nod to the financial stability camp; there is a case for no more QE and maybe at some point the odd rate hike). The second would be to wait longer for further improvements in the debt  income ratio i.e. the propensity for households to resume some re-leveraging. Now of course that can come from stronger incomes but there seems to be a little of a catch- 22 embedded in that. The other, is to give some regulatory relief to  encourage more mortgage lending, even rolling back on the 80 percent LTV formula for example. However that is about as likely as getting a GDP forecast correct.

Either way, the idea that the economy is “ready” for a removal of accommodation and that there is any sense in it from the perspective of rising inflation expectations and a stronger real growth outlook is nonsense. There is some logic in giving up on expecting normalization to previous growth trends as a prelude to any rate rise (Yellen’s 2.5 percent threshold). This is reflected in what was then but not now a stronger supply side economy and a matching demand side, consistent with a greater share of consumption in owner occupied housing. But then rates are naturally very constrained in the normalization process and type 2 errors abound if the objectives of any lift off are not clearly understood. Note that Yellen’s 2.5 percent seems low in that all you need on a year over year basis is 2.5 percent quarterly growth for 2015h2 based on the Atlanta Fed’s current tracking for q2 GDP. However if the above analysis is right, this may still be too high. Moreover, note that for the past five years 2 ½ percent has been somewhat elusive anyway with the average through to 2015q2 being 2.2 percent and only above 2 ½ percent 9 out of 22 quarters, albeit 4 of them in the last 8 quarters. But please let’s not call this transitory! (Truth be told, we think the Fed is obliged to talk up the economy because if they were brutally honest, the economy what vestiges of optimism remain in the domestic sectors could quickly evaporate).

Meanwhile in the medium term it is possible that if there is an exogenous positive productivity shock, consumption ex housing trend can bump higher, perhaps even bumping owner occupied consumption higher too via the improved debt income dynamic. Though, our indicators suggest that too is still not on the horizon.

In general the Fed is necessarily bound to do very little, if anything. And if they insist on tying policy blindly to ill defined expectations on say inflation or full employment, the danger of a gross policy error builds. In the extreme imagine that core CPI was 2 ½ percent but it was all in housing inflation at 4 percent with full employment would they really think it a good idea to remove all “accommodation” with rates at 2 -3 percent. The scary thing is some people would say yes. The scarier thing would be the resulting economic crisis.

 


 

Deutsche Bank continues, but this is the punchline. And all of this, of course, is or at least should be well known to Zero Hedge readers. As for the key message here is, it is simple: it is not just the "fringe blogs" who are telling the truth anymore, it is now the turn of the "very serious people", and as everyone knows, once one dares to call the emperor naked, soon everyone else does. Which, incidentally, would be the final disaster for the Fed, which for the past several years has had just two things: a printer and "credibility"... if only among the "very serious people."

Now, the latter is about to evaporate. Which means all the Fed will soon have is a printer, which it will have no choice but to operate on turbo until such time as the residents of the Marriner Eccles building are driven out by angry, if armed, citizens.

 


 

And perhaps just to confirm once again we were right all along, in yet another amusing incident involving a Federal Reserve economist, yesterday none other than St. Louis Fed's David Andolfatto, in an oddly defensive moment, had this to tweet yesterday:

David, of course, is the same St. Louis Fed career economist who in November accused Zero Hedge of being "dickheads", something for which he promptly apologized thereafter.

Our response to the St. Louis Fed economist is simple:

The problem for Andoflatto, and his equally clueless peers across the US central planning bureau also known as the Fed, is that what has been obvious to us from day one, is finally spreading among the very people whom the Fed decided to bail out while crushing the middle class it was supposed to protect.

As for Andolfatto's latest tweet faux pas, he promptly deleted it. Because that's how the Fed rolls.

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CarpetShag's picture

Abit onus, obit anus.

doctor10's picture

gotta have jobs to have a "housing led recovery"

takes a while for capital investment to spool up and generate yields.

just sayin'

kaiserhoff's picture

Housing will be godawful.

Bonds will be worse.

max2205's picture

That would finally kill off the 95% ers 

espirit's picture

Fringe blogs and "very inFLUential people" telling the truth?

I can believe in ZH and make my own decisions, thank you very much. 

NoDebt's picture

I find it apropos that David Andofatto's barb would so completely miss the mark.  Not just petty and childish, but totally lacking in understanding of the foe he is attacking.

He's made ZH's point perfectly about the Fed not even understanding the nature of the problems they face.

 

espirit's picture

So go housing valuations, so go local tax valuations.

They should be afraid, very afraid.

No moar 7.5 - 8.00% retirement builds for public employees.

Yes We Can. But Lets Not.'s picture

Not really. Tax valuation down 50%?  Millage rate up 100%.  Voila, revenue problem solved, though collecting might  become more difficult.

Greyhat's picture

Of cause, they will always find a way to suck out your blood. :)

It's easy to understand: After Bush they gave you Obama, a nicely painted liberal sheep and now they slaughter it publicly so that you vote for the "hawk" they want to see in office. Moar woar, moar ammu, moare fireworks... Long CNN! 

Thats the "american manifest destiny dream", they pay, you dye. So if you behave like brave mercenaries everything will be all right, thats your role in their grand game.

7 countries, 5 years was not workable, but now you may continue after some recreation.

forexskin's picture

and nowhere does DB refer to the huge overhang of housing inventory being held off the market on large bank balance sheets, listed as foreclosed assets valued fully to model. what could possibly go wrong with a self serving analysis that prescribes moar QE or the fed's (and the banks) dick will fall off.

these assholes are going down, and this is not so much truth as the first whispers of a rising blamestorming creshendo.

Sages wife's picture

ZH cred is growing exponentially. It might shine even more without the "I told you so". When you're good, everyone knows it.

Keyser's picture

The "finger wagging" precursor to collapse is well under way... Soon there will be press conferences filled with fire, brimstone and spittle blaming someone else for the necessaity to ban cash, nationalize your state pension fund, implement currency controls, raise taxes and finally to go to war... 

Gobbler's picture

The FED is caught in a box.  Raise interest rates, and the house of cards collapses.  Deflationary depression.  Keep interest rates at zero and settle for an endless deflationary recession.  Pick your poison.

kaiserhoff's picture

Yes, and with a lot less man hating and America bashing,

  we might even keep a few grown ups around here.

philipat's picture

Agreed ND, as is the Fed's "Response" to the "Problem" which is a further "Double seasonal adjustment". They are very clearly demonstrating themselves to be clueless. I would contend that seasonal adjustments (ALL seasonal adjustments) are totally unnecessary if one simply uses Q1 2015/Q1 2014  (And so on for Q2, Q3 and Q4)) data together a Moving Annual Total (MAT). The whole point of a Moving Annual Total is that it recognises and automatically adjusts for seasonality.

Incidentally, using the above approach, the Fed would have looked better in Q1 2015 because GDP "Only" shrank by 0.7% compared to 2.1% in Q1, 2014!!

Handful of Dust's picture

One of our former houses is still up over 385% since 2002. My Dad built it and knows for a fact it ain't worth 1/3 of that even when you consider its location. It's interesting because between 1985 and 2002 it went sideways in price or maybe even dropped a bit.

 

The Great Correction will be very painful for 95% of us i suspect. I have no doubt Bankers and Wall Street and DC will walk away [again] unscathed.

mvsjcl's picture

"...Fed has the outlook not just horribly wrong, but completely misunderstood."

 

More of that "Fed is completely clueless" bunk. That's what they want us to think.

 

DeadFred's picture

This data has been accumulating for years, why is this article being published now? What game is being played now that wasn't allowed last year? Analysis like this could have been done years ago and I don't believe some guy just had an 'Ah Ha!" moment.

blindfaith's picture

 

 

YES AND OF ALL THE ROTTEN BANKS, THIS ONE TAKES THE CAKE.  A foreign bank ( German) walks up to the Fed window and borrows FREE  money and you can't, lends it to blackrock and other hedge funds to buy the house you just lost so you can rent it from them.  Then bundle the rents up and sell them to your retirement fund.

Brilliant.

bunnyswanson's picture

"Question our judgment, not our motives" (VP Biden during commencement speech at The Thief Factory (Yale).

BoredRoom's picture

I'm praying for a crash, but before depositer confiscations. I've got a contract on my current home for top $, and my eye on numerous farms in SE WV. No traffic lights? No fast food? More black angus than people? $240 annual property tax on 100K? Low Obama son quotient???

 

 

it's a no brainer....

tenpanhandle's picture

Oboma's economy has taken care of me so I don't have to worry about depositer confiscations.

winchester's picture

dude, you post links of 2006 & 2012...

wtf is wrong with you...

TeamDepends's picture

Stawks will go crashing
This Yellen's a curse!

kaiserhoff's picture

I'm a poet,

  and didn't know it.

bigkahuna's picture

If the fed ever smells their own poop then the market is going to go down very quickly - but the fed is a 1 trick pony and their trick is the market and that is it! They chose their path - what a bunch of evil lucifarians or plain fucking idiots, either way not good.

They are going to keep holding out as long as possible, which has thus far been an impressive duration. I dont think anyone knew they could hold on this long.

conscious being's picture

The longer they hold out, the greater the sytemic damage they do. No one realized they intended to kill the goose laying their fiat eggs.

Squid-puppets a-go-go's picture

first Citi, now Deutsch.

That's 2 drops of Ice-9 dangling over the ocean surface

Hobo Sapien's picture

+100 If I remember, there was a huge "FWOOM!" sound, a strange stillness, then immensely powerful storms. Going to have to dig that out and read it again, thank you.

If anyone is unsure of the reference, let me help there:

http://www.amazon.com/Cats-Cradle-Novel-Kurt-Vonnegut/dp/038533348X/ref=...

;-)

Perimetr's picture

Don't worry, they will seasonally adjust everything a few more times.

BUY!!

BoredRoom's picture

plus, as I surmise, there will be a lot more short squeeze sheeple shearing of the 'savvy' investor before it goes bust

ebworthen's picture

Yes, it's bubble #3 since 2001, and Deutschbank and all the other EU and U.S. TBTF banks will be bailed out, AGAIN.

People say it won't happen again, they wouldn't dare, but they are committed to the course - and who will stop them?

Look what the banksters and elites got away with in 2008, and continue to get away with.

They will push this all the way; capital controls, getting rid of cash, and martial law.

eyetaliano's picture

David Andoflatto's tweet infers that Global Warming actually exists which is a double whammy on his intellect.  Not only is he a economic moron but he also delves into the realm of pseudoscience as well.  G_D help us all.

flash338's picture

Stack silver. Wait for a silver spike. Buy land.

Beowulf55's picture

Stack silver. Wait for a silver spike. Buy land. And let the government tax you till they get the land........great idea.....

 

Untl they stop taxing your property you will never own it and will always be a serf of the state.....

Lets Buy The Dip's picture

what about the SHANGHAI market holy hell ==> CHART IS HERE

That is up over 100%, a bubble or not, people have made a killing there. 

Housing could be just being pumped up on xmas fairy dust?

LawsofPhysics's picture

LOL!!!  right, now remind us, what is the average wage again?  remember, when food and housing gets more expensive, so does the SNAP program...

 

just sayin'

j0nx's picture

Crash the housing market?? Certainly not where I live. Been waiting 2 years in a shitty rental for it and still prices keep rising...

surf0766's picture

IN a $250-300 K neighborhood in SE PA. Not much happpening. House across the street empty for almost 3 years now. Others were finally rented and never sold. Local market never recovered. Number of empty houses is the same as in 2009.  Township is monitoring because of thefts of copper etc..

OldPhart's picture

You that are making $50k per year prepare to make $30K per year.  You making 100k per year prepare to make $1,000k per year. Thus it is written, thus shall it be.

falak pema's picture

man can do what he wills but he cannot will what he wills.

That's the difference between obscurantism and reality.

The FEd is like the Popes, it takes its allegorical tales literally, concealing its legendary origins, instead of admitting it is a fable and as such should be treated as a moral allegory.

QE is an allegorical tale which will one day disappear like a puff of hot air. And the world of power all swears it is real ! 

joseJimenez's picture

Where exactly does the bear shit in??

OldPhart's picture

My neighbors outhouse,  That Bear has got to go, (well we all have too), but he has to go extinctually.  It sucks to fight a bear to take a shit, when just meeting a bear will give you the shits.  (trust me on this)

Meet a wild bear on a face to face encounter and you WILL shit yourself into a literal disgusting mess that the bear is even disgusted and leaves you alone.  (Used the same tactic against the wife and it works!)  Haven't run into a grizzly (other than the wife), so can't vouch for results..  [Really, meet a bear face to face, from five feet away...You WILL shit yourself, it's kinda like having the sound of the WHSST of bullets going by your ears except there's this really big, pissed off, montrosity directly in front of you that has a fondness for fresh meat and has three cubs behind her]  As I said, you WILL shit yourself,

Best tactic is to retreat and make yourself as small as possible and offer nothing that seems theatening.  Hmm, that seem's a plausible tactic for what war criminal government?

ZH Snob's picture

happy days!  Douchea Bank has validated my opinion.

marathonman's picture

Ponzi schemes always unravel eventually.  Forty years is a long time to keep a Ponzi scheme afloat. 

Cynicles's picture

Only if the old lady is Lady Freedom.