Jerome Powell’s announcements this week sent stocks up quickly. But these announcements have not had the same impact on the bond segment and, above all, will have a significant impact on real estate.
Wall Street went up in flames at exactly 8:39 p.m. Wednesday, when Jerome Powell told reporters that “the steering committee [de la Fed, NDLR] does not actively consider raising interest rates by 75 basis points at future monetary policy meetings.
Thus, this single “small proposal” was to provoke the most powerful rally bullish trend in US indices since March 3, 2020 (and one of the shortest, with a relapse the next day).
Euphoria is not common
But while short sellers on the Nasdaq were thrown out the window, falling prey to the volatile derivatives trap, 10-year U.S. government bond yields remained at over 2.96% while 20s recorded the worst close since falling. 2018.
Jerome Powell seems to have lived up to his reputation as Wall Street’s best friend…but what has he announced that justifies shareholder euphoria? And why isn’t that alleviating stress among bondholders, primarily concerned about the Fed being less hawkish ?
It is impossible to explain the origin of diametrically opposed reactions, hence the call of a trap designed to clear short positions that have reached their climax.
Because the Fed will start reducing its balance sheet size (from June): it will start from $47.5 billion over four months, then accelerate the sale of its assets to $95 billion a month in September and continue this process until the amount is reduced from 9 billion dollars to 6800 billion dollars, which will take about 3 years.
Yes, 3 years of gradual liquidity drying up… but the mass of “M2” has grown in 2 years from $15,000 to $21,000 billion: the Fed will absorb only half.
But the diplodocus in the room – while Wall Street has recently focused on the little fluttering butterfly of rates and balance – is ” reverse repos from the Fed since May 2021, i.e. the fact that the Fed “borrows” liquidity from the market every night (instead of pouring it in).
At the end of April, every night the Fed was absorbing $2,000 billion, which is an absolute record in this area!
Real estate will be hit hard
This is so much less money that banks can have to finance speculation.” Overnight “, but also to provide long-term real estate loans.
But above all, the mechanical impact of the rate hike will wreak havoc among floating-rate borrowers, that is, those who have been able to purchase property at less than 3% within 18 months. see their monthly loan payments explode.
A little reminder: in such cases, for the first three years, the borrower pays almost only interest and a small fraction of the “principal”… and now this item increases by 225 basis points in four months!
All the buyers who have seen too much, or who have “counted right” by betting moderate rates until 2025 (due to the temporary inflation narrative), are starting to pile up late payments… and the most careless are already out.
Foreclosures on real estate as of the end of February in the US were up 140% yoy, with at least 3 million borrowers overdue, including 2.1 million over three months (mostly ending in eviction, during normal times).
Even faster than in 2008.
And of course, KDS (credit default swaps) on mortgages exploded, and much faster than in 2008, because at the time banks and rating agencies were in complete denial, and bond managers were hiding their heads in a bag so as not to see all the “for sale” signs on return to their mansions with a swimming pool on the outskirts of the city.
And posters for sale » (sales) are starting to return to the lawns of residential areas: this is not a cause for concern and even rather encouraging, because the real estate market has been in short supply for 2 years.
Finally, the supply is getting a little more plentiful again, and there is no shortage of solvent buyers like BlackRock, Fidelity… or ” family office » diversify the wealth of their wealthy clients.
But a bubble is a bubble, and banks will have to provide defaults that will cut their profits in the coming quarters with a scissor effect associated with falling applications for loans from the middle class, which will not be able to do this. t afford to borrow at 5%.
There is no chance of seeing the scars from the bond crash that have been happening since December 20, 2021, which represent historic violence, disappear over the next few weeks.
A 225 bps rise in mortgage rates – and possibly 250 bps before the end of May – will inevitably stop the upward spiral in house prices. Since the 1960s, such strong and rapid growth has always burst bubbles.
And in Europe?
What is happening in the US real estate market is a relentless omen of what will happen in Europe in three to six months.
The ECB is fueling the expectation of a six-month break with the Fed, explaining that the rate hike is ineffective against imported inflation, which is recognized by most economists.
But on the other hand, they are terribly effective at deflating asset bubbles, and it has been a decade since the rise of the “rock” impoverished the middle class (the poorest benefiting from a substantial APL) and reduced the number of newcomers. buyers. Hence the hyper-concentration of real estate assets over the course of a decade in a few very large hands… just like stocks: 85% owned by the top 5%.
The super-rich will weather falling real estate prices and refrain from selling a rather illiquid asset, they have a dynastic (or generational) vision: the stone is always valued in the long run, the heirs will be richer in 20 years, regardless of any fixes in the meantime.
On the other hand, the borrower in the main residence is the main asset, and who has become over-indebted – almost free money obliges – to make a small rent, will find himself grabbed by the throat and forced to sell.
At the moment he is at the highest level, so a lot: no ” negative equity (or hidden loss of capital), but in a few months, buyers in the crazy period from May 2020 to December 2021 will quickly find themselves “under water”.
No more capital gains from resale, but losses that can escalate very quickly, as in 2007/2008, and the creditor bank, in case of confiscation, will not be able to renegotiate their marbles: bankers know how it happens when something goes wrong , and this will lead them to significantly tighten credit conditions, fueling a deflationary spiral in real estate.
BlackRock, Berkshire Hattaway, and a few big pension funds could buy everything back in the United States, but why rush when everything can be bought at a bargain price within 2 years?
The same reasoning applies to bonds and mortgages: patience is good.