Monday, January 02, 2006

Leading Indicators Have Now Turned: PIMCO

Leading Indicators Have Now Turned: PIMCO
Paul McCulley
at PIMCO had some thoughts on housing recently. "Q: PIMCO is following the U.S. housing market very closely, forming a research team and sending people around the country to observe regional markets for signs of a slowdown. What did the team have to say at the December Forum?""McCulley: Scott Simon, our mortgage guru, gave a special presentation..Their key conclusion is that the leading indicators of a slowdown in housing have clearly turned. Going back to September, the group identified the leading indicators but those indicators had not yet turned at that point. The leading indicators for the housing market have now turned and we anticipate that the market itself will be turning in the months immediately ahead.""One key indicator is that the inventory of unsold homes is rising, as former buyers are becoming sellers, trying to monetize their speculative gains. Price discounting in selective markets is a second leading indicator. And probably the most important indicator that we are seeing is a severe slowdown in the affordability associated with exotic mortgages. In fact, we’re now seeing layoffs by mortgage brokers who specialized in exotic mortgage creation.""A key characteristic of the property market is that it’s very momentum-driven. This is sometimes called a 'reflexive' market, meaning that people are more excited when prices go up even though there is less value, and less excited when prices go down even though there is more value.""Because of reflexivity, once momentum turns and home price appreciation slows, we should see a rather dramatic slowdown in volumes. Home prices don’t have to actually fall for you to have a sharp slowing in the volume of transactions. That is a key analytical aspect of our forecast that a slowdown in home price appreciation will have a bigger impact on the household’s ability to withdraw equity than the consensus probably thinks.""Q: In terms of specific sectors, has the latest cyclical outlook affected PIMCO’s positive view on mortgage-backed securities? McCulley: We are still very enthusiastic about the mortgage sector, which has cheapened up as the marketplace has responded to the flattening of the yield curve.""Q: Why did the European Central Bank (ECB) decide in December to raise interest rates for the first time in five years? McCulley:..essentially the ECB wants to rein in some of the froth that seems to be in the property market..The ECB doesn’t have the dual mandate of supporting growth and containing inflation that the Fed does, but rather only an inflation objective. And the ECB also is a bit more inclined to see and address bubbles in asset markets than the United States Federal Reserve is."