The big banks may be dismissing the current wave of soaring prices, which as we noted previously has been driven mostly economic reopening categories such as soaring used car prices where a pandemic-induced demand surge has run headfirst into temporary shortages, production bottlenecks, and supply chain disruptions...
... but they are increasingly zeroing in on what may well be the source of non-transitory inflation over the coming years. Just last night, Goldman highlighted three such risks for longer-term inflation pressures including:
- A sharper rise in wage growth: The first risk is that wage growth could rise to a much faster pace than reached last cycle if current signs of worker shortages and labor market tightness prove more persistent than many expect. The starting point for wage growth is unusually high for an economy emerging from a recession.
- A multi-year boom in home prices boosts rent inflation: The second risk is that a multiyear boom in US home prices could drive shelter inflation much higher.
- Temporary price spikes raise inflation expectations substantially: The third risk is that the current price spikes caused by temporary pandemic effects could have a more lasting impact if they raise long-term inflation expectations substantially (i.e. transitory proves to be non-transitory). Last week brought hints in this direction, including a 0.4% jump in the University of Michigan’s measure of long-term household inflation expectations, a modest increase in long-term inflation expectations in the Survey of Professional Forecasters, and further increases in market-implied inflation compensation.
Of these three, Goldman is most concerned about the second one, and dedicated a separate research report (discussed here) precisely about the risk of sharply higher home prices.
In a report from Goldman's economists, the bank warned that "a national housing shortage will fuel substantial home price appreciation for at least a couple more years." Goldman now expects that shelter inflation is likely to surge to 3.8% YoY by end-2022 — boosting core PCE by about 0.3% relative to today — and to exceed 4% in 2023 (!), a higher rate than at any point in the prior economic cycle. At that point anyone countering that (hyper)inflation is transitory will be laughed right out of the room.
In other words, Goldman just predicted that by 2024 home prices will be rising at a pace far faster than the widely recognized 2006-2007 housing bubble, and that the spillover from this surge in prices will make the coming hyperinflation anything but transitory.
We bring this up again because this morning another prominent bank analyst - Deutsche Bank's chief credit strategist Jim Reid - published a similar note of caution regarding soaring home prices.
Reid begins with the familiar background: "around many parts of the world housing markets have surged during the pandemic. Huge stimulus, low and suppressed interest rates, government tax incentives, demand for more space in the new world, and limited supply have created a boom that surely few could have predicted when the pandemic started."
Next, the credit strategist shows the US housing boom in perspective with his Monday Chart of the Day...
... and writes that real home prices were the same in 1999 as they were in 1894. So, remarkably, besides being a good inflation hedge, home prices are little besides having been range bound around inflation for over 100 years. However, over the next 7 years they rose over 60% inflation adjusted before slumping 35% in the next 6 years when the housing bubble burst.
Well, second time may be the charm because from these lows, they are now back up nearly 55% and less than 1% off their all-time real adjusted highs and over 10% above pre-pandemic levels. Indeed, as Reid predicts, they will probably hit record real adjusted highs when the latest data is released next week (they already have according to Black Knight and other pricing services).
Reid's ominous conclusion is that the recent surge in home prices "is nearly on the same national scale as it was in the lead-up to the US housing bust that precipitated the GFC", and he concludes rhetorically: "a new paradigm or a huge worry on the horizon?"
Spoiler alert: it's the latter.