US housing prices revert to long-term per capita income growth

Over a long period, home prices tend to follow growth in per capita income. After bouncing off the recent lows, home prices have once again reverted to their long-run growth trend.

Source: JPMorgan

Historically, incomes (total incomes of everyone over 15 years of age divided by the population size) have grown at roughly 5% per annum (although this growth has been more modes recently). In the next few years house price appreciation (HPA) will likely stay in that range as well (or lower). In fact the CME Case-Shiller futures are forecasting the average HPA to be just above 3% per year in the next three years. And unless incomes in the US somehow experience a dramatic upturn, HPA should stay subdued.

Source: JPMorgan

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BOJ's JGB holdings exceed ¥110 trillion; BOJ, Fed in a QE race

The Bank of Japan continues to build its holdings of Japanese government securities. The holdings crossed ¥110 trillion, now representing 23% of the nation's GDP. By comparison, the Fed's treasuries holdings represent 11% of the US GDP, while its total securities holdings (including MBS) is roughly 17.5%. Of course going forward we have a "race" between the two central banks.

Source: BOJ

The currency markets seem to indicate that the BOJ will ultimately win the race, as the yen continues to weaken. This is driven by three factors:

1. Japan is still facing worsening economic conditions, particularly weakness in manufacturing (see FT story)

2. The new government will pressure the BOJ to do more for the economy (see post).

3. Continuing pressure from China over the disputed island (see NY Times story) creates further downside risk for the yen.

Yen per one dollar

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Barclays' forecast for gold in 2013

Just as DB, Barclays Commodities Research has been fairly constructive on gold. Here is their reasoning:

1. Although non-commercial positions remain elevated, they are off the recent highs reached in the run-up to the QE3 announcement. Tactical allocators have taken some profits due to the recent stability of the dollar (see discussion). That reduced some of the "fast money" in the market.

Net non-commercial gold futures positions (CFTC)

2. There is a common belief among metals investors that retail activity in the US is a good leading indicator for the direction of gold prices. This is quite different from equities, where large retail participation tends to indicate frothy markets.

Barclays: - Physically backed ETPs rose for the fourth straight month, taking total metal held in trust to 2645 tonnes, yet another fresh high and almost the equivalent of our annual mine output estimate for this year. US gold coin sales more than doubled m/m and trebled y/y.

3. Central banks continue to be net buyers. Demand from China's official sector is expected to increase (see discussion).

Source: Barclays Capital

4. Interest from China's private sector seems to be improving, as the Shanghai Gold Exchange volumes pick up.

Source: Barclays Capital

5. On the supply side, global gold mining output is expected to remain roughly flat in 2013.

Clearly the largest risk for gold remains the strength of the US dollar. That is why Barclays' projection is not nearly as aggressive as DB's. They forecast gold to reach $1815/oz in 2013.

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Two Fed officials speak out against the latest FOMC policy decision

We are seeing some dissent among the Fed officials with respect to this week's decision.

1. Richmond Federal Reserve President Jeffrey Lacker, who voted against the FOMC's last policy decision, remains uneasy:

Reuters: - "I do not believe that tying the federal funds rate to a specific numerical threshold for unemployment is an appropriate and balanced approach to the FOMC's price stability and maximum employment mandates," he said in a statement, referring to the Federal Open Market Committee.

Focusing on MBS purchases pushes capital into the housing sector - and according to Lacker should be left to the federal government, not the central bank.

Reuters: - "Deliberately tilting the flow of credit to one particular economic sector is an inappropriate role for the Federal Reserve," he said, adding that trying to influence credit allocation within the economy was a function of fiscal policy.

2. Dallas Fed President Richard Fisher calls the latest FOMC action a "Hotel California" policy (with respect to the expansion program, you can "check out anytime you like, but never leave").

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US manufacturing stabilizing

In spite of some conflicting data coming out of the US manufacturing sector in November (see discussion), the Markit manufacturing PMI is consistently showing signs of gradual expansion.

Econoday: - The first half of December has been very good for the nation's manufacturers based on the PMI flash index which rose to 54.2, up a solid 1.4 points from the final index for November. A reading over 50 indicates monthly growth in business activity and a reading over the prior reading indicates a greater rate of growth.

Details are solid across the report led by monthly acceleration in new orders which are up 1.2 points to 54.8. A special highlight is the index for new export orders which, following a long streak under 50, first popped over the breakeven mark last month and is now at 52.8. This suggests that foreign demand is on the mend.

Other readings include a strong and sustainable rate for output and -- in a special positive -- a strong and increasing rate of employment where the index is at 54.4. Inventory readings show slight destocking which is ideal for future output and employment. Price readings are heating up especially for inputs which is consistent with the overall increase in activity.

PMI greater than 50 indicates expansion (source: Markit)

Markit economists are quite upbeat on the report:

Markit: - The U.S. manufacturing sector is showing signs of regaining momentum as the year comes to a close. Producers reported the largest monthly increase in output since April, with the rate of growth picking up for the third month in a row, suggesting output is now growing at an annualised rate of around 4% compared to the contraction seen back in October.

Such a steady run of improved growth of production is a good indication of a turning point in the economy as a whole, especially as it is feeding through to higher employment. The manufacturing sector has been acting as a drag on the official payroll numbers in recent months, but this situation looks to be changing as firms take on increasing numbers of workers in line with fuller order books.

The next milestone is to see this trend confirmed by the ISM index (otherwise known as the NAPM Survey), which will come out in January. It would make no sense for the two indicators to keep diverging as they have in November.

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China's market responds to improving PMI; institutions getting involved

HSBC China PMI shows that manufacturing continued to expand in December. The rate of expansion is still low, but consider the fact that this last reading puts the PMI index at the highest level in 14 months. This confirms earlier indications of stabilizing growth (see discussion).

Source: Markit/HSBC

The equity market moved up sharply on the news.

Bloomberg: - The Shanghai Composite Index climbed 3.5 percent to 2,134.22 at 1:20 p.m. Trading volumes were more than double the 30-day average for this time of day. Anhui Conch Cement Co. and Sany Heavy Industry Co. jumped more than 3 percent after the preliminary reading for a manufacturing index by HSBC Holdings Plc and Markit Economics increased to 50.9. Citic Securities Co. rose among brokerages, while Industrial & Commercial Bank of China Ltd. rallied the most since May 2011.

Shanghai Composite (source: Bloomberg)

As discussed earlier (see post), with the retail investor having capitulated, institutions could take advantage of this market. And that's precisely what is taking place.

Bloomberg: - “The data show the economic recovery is on a solid footing,” said Wu Kan, a Shanghai-based fund manager at Dazhong Insurance Co., which oversees $285 million. “There’s speculation that Ping An Insurance is increasing its positions in Chinese equities.”

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Bank reserves still down on the year; should ramp up shortly

Some MBS settlements have now been reflected on the Fed's balance sheet, as agency paper holdings increase.

Bank reserves are also gradually moving up, though still down for the year. So far the growth in reserves has been underwhelming.

Bank reserves (soucre: FRB)

With the newly announced treasury purchases, this should pick up steam. And the settlement schedule will be much less "lumpy" than agency MBS.

One thing worth mentioning here is that the US treasury will be borrowing $45bn a month effectively interest free. That's because the Fed passes interest income back to the Treasury (less its own expenses) via earnings distribution once a year. This certainly helps reduce pressure on Washington to cut spending quickly - the can will be kicked down the road once more.

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Slack in resi construction industry holds back jobs growth

The story of continuing weakness in US construction labor markets seems puzzling. Construction payrolls hit a new multi-year low (discussed here), yet both housing starts and construction spending have picked up.

Merrill created a chart that shows construction jobs as percentage of housing inventory in the US. That ratio is at the lowest level since recordkeeping began.

Source: Merrill Lynch 

Merrill argues that it's a sure sign of construction payrolls bottoming out.

Merrill: - One way to gauge the amount of potential construction hiring is to compare construction jobs to the housing stock. Naturally, the housing stock has grown at a slowing pace over the past several years given the sharp decline in the pace of new construction. But we believe the decline in construction jobs was excessive – the ratio of construction jobs to the housing stock is at a record low (data go back to 1965), just slightly below the troughs of prior housing cycles. This suggests construction companies are operating with reduced headcount relative to prior downturns.

They are probably correct, but it seems the industry may have sufficient slack to increase output without significantly increasing payrolls. Here is a simple exercise. Let's take residential construction spending in the US, adjust it for inflation and see how many resi construction payrolls are deployed per one million dollars in spending. For example if we spend $24bn per month on residential construction and resi construction payrolls in the US are 560K, that represents 23 workers per $1 million spent in a month. The lower the number of workers, the more "headcount efficient" the industry is.

Spending in 2011 dollars

The industry seems to be improving its efficiency in recent months, but still has a great deal of room to go. Construction was most efficient during the building peak in early 2006. That's because the sheer volume of homes under construction allowed for high efficiency (just as most industries become more efficient with increased volumes). This tells us that the industry indeed has some slack and can increase output without proportionally increasing payrolls. Which means that if construction booms in 2013 (as many expect it), jobs will certainly increase but at a much slower pace (at least initially).

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