On Wealth Effects of Fed Policies:
Housing Is Likely The Bright Spot
Leuthold Weeden Capital Management
By Chun Wang
November 19, 2012
We’ve mentioned before the rapidly waning effect of the Fed policies. October was a good proof of that, with the S&P 500 index down about 2% (top chart). The stock market is no doubt part of the wealth effect the Fed was trying to create, but home prices, which represent the bulk of the average person’s net worth, and personal income should also be considered a big part of the wealth effect.
As shown to the right, the stock market wealth effect has so far been the most direct and pronounced effect. But it has been wearing off, with the subsequent rally after each Fed stimulus weaker than the previous one.
The housing wealth effect, proxied by the Case/Shiller 20-City House Price Index year over year change, has just started to have an impact. This effect is probably the most promising one going forward.
Until recently, banks were very slow in passing on lower interest rates to home buyers/owners. The problem was, although the demand for mortgages got stronger, banks were unwilling to loosen lending standards, according to Senior Loan Officers Survey (top chart, next page). However, we believe this is now changing. QE3 has widened the gap between the rates homeowners get and what banks can get in the secondary market. This provides a much bigger cushion (spread) for the banks, so they can take more risk by extending loans to people with less than perfect credit scores. This will be a boon for the housing market going forward.
The personal income wealth effect is the most disappointing. The bottom clip of the previous chart shows very anemic growth in Per Capita Disposable Income, and it seems to be stalling again.
The stock market and housing are not what generate income for an average person. Jobs do. As we mentioned in our last report, QE receives a failing grade for boosting employment. We think the link between QE and job and income growth is obscure at best.
The main issue is not the supply of credit to businesses, but the macro-economic uncertainties both here and abroad. This includes the fiscal cliff and tax regime changes within the U.S., as well as the external risks stemming from the Euro-zone and emerging countries such as China.
The uncertainties have dampened the demand for credit by businesses, which is reflected in the Senior Loan Officers Survey shown on the right. Although lending standards have been loosened and credit spreads have come down, demand for C&I loans by large businesses has deteriorated recently. The uncertainties are preventing businesses from opening up their checkbooks to spend and create new jobs. We don’t expect this to change quickly as long as these uncertainties persist.
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