Given investors’ heightened concern, first regarding Greek fiscal solvency and the future of the European currency union, and then more recently China’s economy and Asian stock markets, many investors may have overlooked the news that U.S. existing single family home prices set a new all-time record high of $281,200 in June. This eclipses the prior record of $277,900 set in June 2007, prior to the bursting of the housing bubble and the subsequent global financial crisis (see chart).
Considering the historically sub-par performance of the U.S. economy since the commencement of the recovery cycle in mid-year 2009, Global Markets Intelligence (GMI) Research took note of the new record high for average existing single family home sale prices. This development is particularly noteworthy within the context of the longstanding debate within financial markets and policy circles over the appropriate level of Fed policy. The recovery in home prices is just the latest entry to a growing list of indicators suggesting that the U.S. economy appears to have moved past the point of requiring extraordinary levels of monetary policy accommodation.
The Fed now faces the predicament of whether to initiate the long awaited, and some might say overdue, normalization of U.S. monetary policy. The discussion surrounding monetary policy normally centers on the Fed’s dual mandate to maximize employment while maintaining stable and acceptable inflation. On the dual mandate basis alone, there appears to be no clear requirement for the Fed to tighten policy in the immediate future. The U.S. unemployment rate, inclusive of marginally attached workers and those individuals working part-time for economic reasons (U-6), remains historically elevated at 10.4% as of July. This suggests ongoing latent excess capacity within the economy. Likewise, core inflation has stabilized at levels that are acceptable to the Fed while U.S. industrial activity remains depressed and retail sales are not suggesting anything close to risks of an overheating U.S. economy.
However, these are far from ordinary times within the Federal Reserve since policy has remained extremely accommodative for such an extended period of time. The return of existing single family home prices to bubble territory potentially presents a policy conundrum for the Fed. In the new post Great Recession/post-financial crisis world, the U.S. banking system is now accountable to the Fed in terms of regulation, capitalization requirements and risk tolerance supervision. The Fed is now in the difficult position where it could conceivably, in the not too distant future, need to scrutinize the banking system for exposure to a brewing real estate bubble. We can’t help but wonder, would it be credible for the Fed to criticize the banks for exposure to an asset class that the Fed itself inflated as a consequence of prolonged extraordinary monetary stimulus?
So will the Fed actually pull the trigger on an inaugural incremental step toward policy normalization at the September FOMC meeting? Views even within GMI are essentially split on this key question. High profile economic data, mainly the employment series (jobs, wages, and unemployment), the core PCE deflator and core CPI, in addition to retail sales and now possibly even real estate prices will continue to drive investor expectations regarding Fed policy over the balance of 2015.
One last point for consideration while attempting to predict if and when the Fed will initiate the normalization of U.S. monetary policy. There has been a good deal of discussion in the financial market recently regarding the level -- or specifically the lack thereof – of adequate liquidity in the secondary corporate bond market. To the extent that suppressed bond market liquidity is an unintended consequence of financial market regulation in the aftermath of the financial crisis, if the Fed intends to begin normalizing policy in 2015, it may be better to initiate the tightening cycle in September. Corporate bond liquidity, and that of the high-yield market in particular, traditionally evaporates while heading into year-end. If the Fed becomes convinced of the need to snug policy, then they may want to avoid rattling the markets unnecessarily as occurred during the taper-tantrum in the summer of 2013, by hiking the Fed funds target rate by the end of October at the very latest.