Housing bubbles and resource misallocation (page 3 of 3)

We can actually note that following the burst in money supply growth in 2001 and 2002, MZM growth has recently almost come to a standstill. In fact, MZM is expanding at the slowest rate in ten years, which would suggest to me that money has already become much tighter.

US liquidity becoming tighter

Certainly, dollar strength and some weakness in commodities as well as slower growth in foreign official dollar reserves do all support the notion that money has become tighter. Therefore, unless the Fed starts to print money once again, the housing market may shortly begin to weaken somewhat, as has already happened in Australia, and in the United Kingdom, where following some unease in the property market retail sales disappointed.

But would printing money by the Fed help this time around? Hardly! Long term US government bonds have rallied while the Fed pushed short term interest rates up, because the bond market loves nothing more than tight money which would deflate the economy and asset prices.

Conversely, another round of ultra easy monetary policies would lead to renewed dollar weakness, some inflationary pressures for consumer prices and weaker bond prices. So, it is likely that nationwide home price increases will shortly moderate and that in some areas (California and Florida) prices will even come down regardless of the Fed's monetary policies.

The stock market rally I expected for April unfolded in May but now the oversold position we had in late April has been replaced by an overbought condition. In addition, the market faces significant resistance between 1200 and 1230. Therefore, while new 2005 highs should be possible, the upside potential seems rather limited at this point. Furthermore, I would expect any stock market strength lasting possibly into August to give way to renewed weakness in September and October.

Bonds are now also grossly overbought and are likely to weaken in the period directly ahead. In the meantime, the Euro has broken down, whereby bearish sentiment on the Euro is now almost as high as bearish sentiment was for the US dollar in late 2004.

Hence I would expect at least some stabilization of the Euro around current levels. Moreover, if investors begin to discount that the Fed may refrain from further increasing rates, a strong rebound in the Euro and renewed dollar weakness should not be ruled out.