Maybe Ben Bernanke has played this hand as well as he could – Mindful Money markets view

20th June 2013

This isn’t quite what markets had been expected. The Federal Reserve says it will begin tapering quantitative easing by the end of this year as Reuters reports. Previous remarks from Ben Bernanke in which he merely suggested the possibility of tapering caused stress in both equities and bond markets, so an actual concrete announcement was certain to cause markets to fall. Asian stocks saw the biggest fall since late 2011.

At least one thing that the market jitters have done is demonstrate that there will be quite a period of nasty adjustment for the global economy. Some markets especially emerging markets and especially emerging markets with current account deficits may be vulnerable to further falls as the US stops keeping rates artificially low and money stops being easy.

It is interesting however that shares, bonds and commodities are all falling. At some stage, of course, equities should return to a better trajectory. That is what an improving economy is meant to signal.

The mood was soured further by falling manufacturing activity in China, explaining the falling commodities in particular.

Yet some optimists believe that after the adjustment, the bull will be back in charge. They expect the next phase of any rally to be led more by cyclical stocks rather than an untypical defensives-led rally which clearly had concerns about bonds at its heart. The era of QE has altered a lot of thinking.

Of course, some analysts had expressed the hope that Fed Chairman Ben Bernanke would have been a little fuzzier in terms of his message this time out and it presents a very interesting welcome present to incoming Governor of the Bank of England Mark Carney. But we wonder if, in a few months time, Bernanke may be viewed as having played a difficult hand rather well. First we were introduced to tapering as a term, which surely signalled his intentions and caused some adjustment, then he expressed him firm intentions to change course. But it is a taper. It is not a cliff-edge or anything like it, even though markets may be behaving as it is. And after all QE cannot last for ever.

For a look at what the experts are saying, here, hot off the fax machine, is Schroders chief economist Keith Wade.

He says: ”

“It should be good news, but markets have sold off following comments from Federal Reserve chairman (Fed) Ben Bernanke that he expects the Fed will end Quantitative Easing (QE) next year. As a result, tapering of purchases is now likely to begin later this year.

“The Fed is responding to signs that the US economy is improving and they have revised up its forecasts for growth in 2014. Unemployment is now expected to fall more rapidly, reaching a 6.5% to 6.8% range by the end of next year.  Asset purchases are likely to end with “the unemployment rate in the vicinity of 7% with solid economic growth supporting further job gains” said the Fed chairman. On the Fed projections this would be by the middle of next year.

“The outlook is still data dependent, but as a consequence of these comments we are bringing forward our expectation of Fed tapering to start at the December 17/18 meeting (previously q2 2014).  Data would have to be quite robust for a move in September this year, which seems unlikely given that the full impact of fiscal tightening has yet to be felt in the US and the global economy remains soft (judging from today’s flash PMI’s for China and Germany). Inflation is also expected to remain low (although the Fed acknowledged this in its forecasts).

“These moves offer a roadmap for the exit from QE and so provide some clarity to the markets. Strong growth would now be seen as bad news by bringing forward tapering, but the Fed will be aware that significant increases in bond yields will hit the recovery through higher mortgage rates. Weaker equity markets could also slow activity by reversing wealth effects. On the positive side investors should have increased confidence in recovery, but the immediate focus will be on the unwinding of liquidity trades.”


30 thoughts on “Maybe Ben Bernanke has played this hand as well as he could – Mindful Money markets view”

  1. Chris Rick says:

    Buy-to-let is a dangerous game. I’m doing it so my comments are biased.

    Buy in a slump or close to it on either side (assuming that prices go up) and you are in with a chance. If it feeds itself then you can get your profit if you wait to sell at a top. So you have to get your timing right twice. Not much chance of that.

    You have to do it over a long term as the periods between slumps and bubbles can be long. Over these long periods a lot can happen, as it has done in recent times, to take away your gains. Even getting timing right might not end up in a gain.

    Why are buy-to-let landlords buying now? Same as everyone else: greed and fear.

    If you have a couple of hundred thousand you don’t know what to do with (sic) and won’t need for a few years then parking it in a property is as good a bet as any. Perhaps a better bet than giving it to an insurance company for an annuity. If the government wants it then it will get it no matter where you put it.

    1. Anonymous says:

      Anyone who parked 200K 5 years ago in housing must be kicking themselves compared to stock market returns.

      1. Anonymous says:

        Looking back 30 years, housing has done no better than the FTSE 100.

        1985 to 2000, the FTSE gave a 450% return versus 150% from houses. Only war brought the stock market back down to parity with housing around 2003.

        1. Anonymous says:

          Agreed, as always it’s about when you get in and out. Most people only look at this due to their own experience.

    2. Patrick, London says:

      BTL also has a detrimental impact on the market, driving prices artificially higher than the natural level of HOME-buying would otherwise demand. Very rare to hear from BTL folk getting out of the game because they fear for the impact on FTBs and wider society.

      Current strategy is/has been:

      Lower rates to avoid debt based collapse -> Knacker savings/ISA rates-> drive more to BTL*-> pump up the market->drive more HOME buyers to excessive mortgages-> freeze rates as you can’t raise em because even more people are leveraged…->… and buy Popcorn.

      *or Stocks, inflating asset prices beyond any sense of their real value, whilst lining the pockets of the Vampire Squid and its ilk.

      1. Anonymous says:

        You forgot to mention that at the end of your life, you will have to sell all the assets that you own to finance your care home stay. Or if not that, pay IHT at a huge rate on the funds that you might pass on to your heirs. Accruing family wealth in the UK requires rather a lot of skill and a good deal of scale to allow successful avoidance of all the traps that the government sets.

  2. hotairmail says:

    There is a direct correlation between incomes and rents as you say. They are NOT related to house prices per se, but to affordability. House prices too are related to affordability and incomes as well, but in their case the Bank of England has a direct bearing on the affordability side of the equation and if credit is readily available, prices will rise to the new equilibrium when costs fall and vice versa.

    I did some tweets on it…I’m sure you could take them apart – it is difficult to get all aspects across in that medium. (for instance I ignore all supply and demand issues for those tweets)

    hotairmail Aug 7 Chart of rents, house prices and incomes:

    hotairmail Aug 7 House prices ARE related to the costs and availability of credit AND local incomes.If prices are rising for the former,it won’t affect rents

    hotairmail Aug 7 Rents are NOT related to house prices. They are NOT related to costs of credit. Purely and simply, they are related to proximate incomes.

    hotairmail Aug 7 Landlords out there who think they will be able to raise rents when interest rates rise, think again. You would have done it already if cld.

    hotairmail Aug 7 What that chart also demonstrates is that any Land Value Tax levied on landlords would NOT push up rents either.

    1. Anonymous says:

      Hi Hotairmail

      As ever one of the main issues is the reliability of the data with differing house price and rent indices etc. and that is before we get to the current debate about what UK wages are doing! Practical economics right now is facing as big a challenge as I can recall due to data issues. Another gift from the credit crunch.

      However notwithstanding all that your chart is rather eloquent I think.

      LSL have published a new estimate of rents.

      “Annual rent rises increase to 2.0%, fastest since September…….The average residential rent across England and Wales is now 2.0% higher than in July 2013, currently
      standing at £753 per month. This is the same absolute level as in November 2013, and is up from an average of £738 per month in July 2013.”

      Applying reverse logic perhaps it is a hint of some wage growth.

  3. Dutch says:

    The problem with any property inflation measure is that the rental market and purchase market are completely different beasts.

    Rent is a cash market and buying a credit market-for most.

    The market for credit-thanks to ZIRP,HTB1,HTB2,FLS-has only been lightly restrained since 2008.The market for rent has been subdued by a crushing deflation in real disposable incomes.As many of the readers here would likely accept,young working families prioritise food and fuel above worrying about their landlords pension position,and it’s this latter reality that will restrain rents for a very long time.

    Whilst many are engaged in a headless search for yield/capital gain,they’ve been immune from downside risks thanks to the very taxpayers who are paying their mortgages for them.

    There was an article in the Guardian this morning about how 1.6 million households are spending 50% of dsiposable income on rent/mortgage.Haerdly a recipe for long term capital gain in that sector.

    1. Anonymous says:

      Just reporting of house prices and rents as “inflation” would be a start.

      Doesn’t help there’s shared responsibility between BoE and Govt and both have spent the last 6 months passing the buck.

  4. Anonymous says:

    Hi Shaun. Are there differences between the calculation of CPIH and imputed rent calculations? Imputed rent must be tied to rent and yet that has over the past 10 years risen as a share of GDP.

    My feel on the link between house prices, rents and wages is that rent is tied to wages at the upper bound because rents have to be paid on money earned not money borrowed. However house prices do effect rents. Imagine house prices fell to 20% of today’s value. And interest rates normalised to 5%, to remove any ZIRP nonsense. And wages remain static. In such a case mortgage repayments on a 3 bed semi in the midlands would be far below today’s rent. In this case rent would have to fall to reflect a more reasonable yield.

    It is only when house prices detach from wages that we see rents “top out” as the maximum people can afford (subsistence wages).

    1. Anonymous says:

      Hi Progrock

      The official view is that imputed rent and CPIH are built/calculated using the same principles. From a 2013 Freedom of Information request on the subject submitted as it happens by a reader of this blog.

      “The method used for calculating imputed rentals is therefore a rentals equivalence method with the HHFCE estimate of Actual rentals for housing as it’s base. The growth in imputed rentals is therefore comparable with this estimate of growth in actual rentals.”

      There was however a change made last summer which boosted the imputed rent levels.

      “As part of the ongoing quality improvement work in HHFCE, data was released on 27th June 2013 (part of Bluebook 2013) incorporating a significant change to the methodology described above. This broadly left the growth in HHFCE imputed rentals between 2007 and 2012 unchanged at around 55% although the level was significantly raised.”

      By significantly raised the impact was £17.6 billion on 2011.

      I have been following other changes and to be honest its makes ones head spin as big changes are made but somehow come to the same answer! Going forwards though the imputed rent growth should be similar to the relevant elements of CPIH and I will be monitoring it….

      1. Anonymous says:

        ok very interesting, thanks for that information Shaun.

  5. Anonymous says:

    Thank you for this column, Shaun. The 1.0% 12-month increase
    that you cited for private rental prices paid by tenants in Great Britain for
    June 2014 is a little scary. When I checked the regional detail, it seems that even for London the increase was only a little higher at 1.4%.

    The actual rentals for housing CPI shows a substantially higher increase for June at 2.4%,but it seems that the difference comes from social
    housing and holiday lets. The CPI movement for private rentals is about the same. I really wonder if this is plausible.

    You give a good rationalisation for why this might be so, in
    terms of buy-to-let owners looking for tenants that are basically housesitters until they can sell their properties for a big capital gain. But the private rentals are increasing at only 0.3% in the North East and North West, where it seems unlikely that landlords would be behaving in this way. Would they even be recovering their costs with such small increases?

    The rent CPI for Canada has a sixth of the sample turn over
    every month so if one assumes that a dwelling changes rent every year (12-month leases are standard here) there is actually only hypothetically a 5/12 chance that a rent increase will ever be registered for any dwelling in the rent sample. If the lease terminates in month five and there is no rent increase the tenant will happily renew and will be there to record no change in month six. If his rent undergoes a substantial increase, he may move elsewhere. If he trashes the place before moving out the apartment may be unoccupied for a month while it is repaired. Even if it is immediately occupied , the Labour Force Survey official may not be able to contact the new respondent in month six, or the new respondent may misreport the rent (e.g. rent per person rather than rent for the dwelling) and the new rent will be discarded from the index. These are problems that would be ironed out if the rotation period was longer. The Kovar imputation, named for a StatCan survey methodologist, was supposed to fix this problem, but it hasn’t been used consistently, and it
    doesn’t appear to adequately address the downward bias in any case.

    The Index of Private Housing Rental Prices keeps dwellings
    in sample for much longer, 18 months, but if British leases tend to run longer, it may still be a short enough period to cause the same kind of downward bias. The reporting isn’t by the tenant, which should be better, but maybe this isn’t always the case. I noticed that the methodology for the IPHRP made no reference to renovations to rental units, where there would seem to be a significant risks that rent increases might go unreported or understated.

    If you are appointed to the ONS Stakeholder Committee as you
    deserve to be, it might be something worth looking into, since the rent index has such a heavy influence on the CPI and the RPI. Andrew Baldwin

    1. Anonymous says:

      Hi Andrew and thank you for the compliment

      There are loads of issues to consider here I think. I still recall the debate over CPIH at the Royal Statistical Society from the summer of 2012 and the feeling that the evidence was in favour of using house prices and not rents and by a considerable margin. However it was ignored and look where we have ended up!

      I note that you are raising additional problems in the way that rents are measured in what is becoming an increasingly tangled web.

  6. anteos says:

    Great article as always Shaun.

    I wonder if rents have been affected by the withdrawal of state support. ‘Bedroom Tax’ and max £500/week must have impacted high end rentals.

    1. Anonymous says:

      Hi Anteos

      Your point about the impact on high end rentals may be a reason why London rents are not as bubbilicious as prices. With the house price rises that have happened rental yields in London must have dropped quite a bit if the 1.4% estimate of annual rental growth is true.

  7. Paul C says:

    We need too build too many houses just like in Spain and then there would be no need to discuss or worry about, CPIH, BTL, interest rates, rent or property investments. Indeed we would all magically become “free” to do something useful once again :-)

    1. Anonymous says:

      Hi Paul C

      Actually some parts of London and in many respects especially mine are giving it a good go! There is a fair bit of building going on in Battersea and then just up the road past the dogs home there are the plans to redevelop Nine Elms such as the new American embassy.

      But overall it seems to be falling short,…

    2. Chris Rick says:

      What a good idea! 3% yearly growth in GDP means it doubles in 24 years? Between now and then it means we’ll need something close to another London, Birmingham, Manchester, Sheffield,… so we had better get on with that building and then some.

      1. therrawbuzzin says:


    3. Anonymous says:

      Just break the planning stranglehold, and allow self build.

      It’s not a difficult decision, do I build myself an affordable high spec spacious home or do I buy a badly-insulated, overpriced, uniform miniscule box built by barratt or redrow ?

  8. Andy Zarse says:

    Hi Shaun I was just pondering whether the cap on the level of housing benefit has exerted much downward pressure on rental levels, especially in London?

    1. Anonymous says:

      Hi Andy

      It may have had an impact as I have already replied to Anteos. But it is hard to be precise and I also wonder if the many foreign buyers of London property have been more likely to rent it out than before and thus had a depressing influence on rents.

  9. Michael Edwards says:

    Interesting, though I’m no expert on price indices. Please can you or someone comment on the following:

    Surely you can’t design a price index without first deciding why you want it: is it to portray the current costs being confronted by the population (e.g. to enable us to convert nominal into real wages) or for some other purpose.

    If the point is to capture the process confronting workers, then shouldn’t the housing price element be split in two: approx half based on rent movements and half based on the debt-service costs of owner-occupation?

    Although people buying housing on mortgages may incur no long-run costs if the timing of buying and selling wins them big capital gains, it’s the current cost of debt-servicing which can hurt and which is the measure of the pain of a financialised housing system.

    The alternative – basing the index on imputed rents for owners (and regarding borrowing and lending as a separate sphere) – is too metaphysical and will, in periods of rising interest rates, underestimate the pain for buyers.

    1. Anonymous says:

      A price index is an attempt to model what the economy is doing. If you purposely design a model to achieve some goal – chances are your “model” is flawed.

      I have previously suggested (in this blog) that the UK statistical bodies should tabulate money spent against products bought.
      This means that owner-occupier mortgage costs can be accurately proportioned – your arbitary 50/50 rental split may not accurately model the real world. Also it means that flawed inflation baskets are not needed, because we model what is really spent.
      Eg. if in 2013 people spent £10,300,000 on 10,000 tons of baked beans and in 2014 people spent £10,400,000 on 9,900 tons of baked beans then we can calculate price per kg each year, and actual inflation. You can extend your calculations to cover almost everything bought.

      Unfortunately UK national statisticians use inflation baskets to arrive at an inflation number which seems to bear little relation to the living costs of the 99% of population.

  10. Merijn Knibbe says:

    My take: (A) the rental equivalence method in fact does not add new information about new prices to the price index, it only gives rents, de facto, a larger weight. (B) the Eurostat HICP price index does not include ‘rental equivalence’ as rental equivalence’ is not actually paid by house owners and the HICP TRIES TO GAUGE THE PURCHASING POWER OF MONEY ACTUALLY SPEND. I think that’s a sound approach. (C) ‘equivalent rental income’ for house owners is an important (and necessary) imputation in the national accounts. However, their spending power does not decrease when rents which are actually paid increase – this contrary to the situation for renters, of course. Which makes that including rental equivalence in the price index biases this index (downwards in the UK, strongly upwards in the Netherlands at this moment). The Netherlands will by the way soon discard rental equivalence and adopt the HICP as the official index.

    It’s i.e. not smart to use rental equivalence to calculate purchasing power of monetary income (in fact: monetary income plus consumer lending).

    Introducing the mortgage interest rate in the price index makes more sense (which, at this moment, would of course *lower* the inflation of the post 2008 period). House prices themselves can also be introduced, quite simply by treating houses like other goods. As bust-periods are not only characterized by lower house prices but by even larger declines of the number of houses sold, this however requires a frequent adaption of weights.

  11. Guest says:

    With regard to UK housing rents, everyone assumes that drivers for this market are the same as the market of housing in general ie house prices. This is not really the case, as you have said in the past, house prices are driven by the cost to service mortgage debt (i.e. monthly mortgage cost vs wages). So when either wages, or mortgage availability go up or mortgage interest rates go down, house prices increase. However housing rent is driven my wages allow. In the end rents can only go up in up in line with wage growth.

    Evidence for this can be seen in following graphs: chart of average earnings vs housing rent since 1987 and chart of average earnings vs mortgage interest payment since 1987.

    Inflation Monkey

  12. With regard to UK housing rents, everyone assumes that drivers for this market are the same as the market of housing in general ie house prices. This is not really the case, as you have said in the past, house prices are driven by the cost to service mortgage debt (i.e. monthly mortgage cost vs wages). So when either wages, or mortgage availability go up or mortgage interest rates go down, house prices increase. However housing rent is driven my wages allow. In the end rents can only go up in up in line with wage growth.

    Evidence for this can be seen in following graphs: chart of average earnings vs housing rent since 1987 and chart of average earnings vs mortgage interest payment since 1987.

    Inflationary Pressure

  13. Anonymous says:

    Hi therrawbuzzin

    The establishment of course regularly claim that inflation is over estimated which leads them to make moves like replacing the higher RPI with the lower CPI. As CPI now represents 24% of the GDP deflator this has boosted GDP too. This was all covered and satirised by Yes Minister some 30 years ago now.

    Tucked in all this is the reason why people are told they are better off but feel worse off…..

Leave a Reply

Your email address will not be published. Required fields are marked *