The Realtors Said What?

From the NAR:

Buckle Up: Home Prices Are Expected To Fall by a Lot—Even If There Isn’t a Recession

The U.S. Federal Reserve has completely upended the housing market, taking it from turbocharged to rapid deceleration.

The effects of the Fed’s rate hikes in its war against inflation are being felt in just about every crevice of the economy, as recession fears are quickly mounting. The stock market keeps falling, companies are scaling back on hiring or letting workers go, and mortgage interest rates are rising even more than anticipated, causing homebuyers to slam on the brakes.

Home prices in many markets have even begun falling from their peaks. Now, the question is how far they will drop—and what fissures will be opening elsewhere in the economy to propel these changes.

The red-hot housing market will likely “have to go through a correction” as “housing prices were going up at an unsustainably fast level,” Jerome Powell, chair of the Federal Reserve, said in a press conference last week.

While economists debate whether the nation is already in a recession or heading toward a downturn, it’s clear that the housing market has shifted dramatically.

“The Fed is determined to cool inflation, and they’re willing to throw housing under the bus to do so,” says Devyn Bachman, senior vice president of research at John Burns Real Estate Consulting. “When you raise [mortgage] rates to the point they’re at today, it breaks the back of housing.”

A year ago, homes were selling in mere hours as throngs of buyers tried to outbid one another by tens, if not hundreds, of thousands of dollars over the asking price. However, when the Fed began raising its rates, mortgage interest rates also went up, making it significantly more expensive for buyers to afford housing.

So home prices have begun coming down from the summer, and many would-be buyers aren’t purchasing homes. Sellers, realizing they missed the peak, are holding off on listing their homes. Many who need to sell are cutting prices.

“The deceleration in housing prices that we’re seeing should help bring … prices more closely in line with rents and other housing market fundamentals—and that’s a good thing,” Powell said last week. “For the longer term, what we need is supply and demand to get better aligned so that housing prices go up at a reasonable level, at a reasonable pace, and that people can afford houses again.”

Some fear the Fed’s course of action could be too much for the housing market to withstand. Prices have been falling from a peak in June. And while prices are still up from a year ago, many real estate experts predict they’re about to fall much further.

This entry was posted in Housing Bubble, Mortgages, National Real Estate. Bookmark the permalink.

44 Responses to The Realtors Said What?

  1. grim says:

    Kaboom, from Barrons:

    Mortgage Rates Hit 6.75%. That’s the Highest Since 2006.

    Another rise in mortgage rates last week cut down on the volume of home loan applications, according to data published Wednesday.

    The average contract rate on a 30-year fixed-rate loan last week was 6.75%, the Mortgage Bankers Association said Wednesday morning. It was the highest such rate since 2006, the trade group said.

    The rise in rates weighed on mortgage applications, Joel Kan, the trade group’s associate vice president of economic and industry forecasting, said in a release. “The steep increase in rates continued to halt refinance activity and is also impacting purchase applications,” Kan said. Refinance application volume was 86% lower than the same week last year, while purchase volume was 37% lower.

  2. 3b says:

    I would have thought everyone who wanted to refinance would have done that by the end of last year.

  3. leftwing says:

    House of Saud to SloJo:

    Piss off you senile old man.

    Guess the positive downstream effect is rising prices at the pump going into the heart of election season….

  4. No One says:

    Grim’s original post is one example of why I hate central planners and central bankers so much. They are jerking people around, manipulating interest rates and the cost of credit to try to stimulate and depress people. Sending false signals. They wanted a housing boom to help paper over the damage other central planners created, now they want to create pain for the same people they lured into property via cheap mortgages. They wanted to fool people in the early stages of inflation, and now they don’t want the blame for playing puppetmaster.
    They didn’t want to sound “uncool” by saying their years of zirp was encouraging people into crypto scams.
    Tough luck for those who imagined the Fed’s free money party would last forever.

  5. Fast Eddie says:

    Sellers, realizing they missed the peak, are holding off on listing their homes.

    Which means no inventory + the NJ/NY/CT area = nothing has changed. The illustrious $650,000 piece of shit will carry on as before. We’ve been down this road numerous times since the inception of this blog. Prices balloon, taxes balloon and then bounce around at the peak. A few houses in our area are reduced 5%, get sold close to asking and we’re lumped in with some housing slaughter in Buttface, Indiana. The media is piss poor in accurate reporting and we’re told to believe.

    Side story; Good Morning America did a 10 minute segment the other day on the safety issues of the next gen NASCAR that was so riddled with mistakes that it was embarrassing. Fans were ripping GMA to shreds. The moral of the story is that the news/business media is strictly tabloid entertainment and often wildly inaccurate. The same holds true for a one-size-fits all housing prediction. Perhaps prices are falling drastically in Peoria, Illinois but they’re simply frozen at the top in our neck of the woods and that’s where they’ll stay.

  6. Phoenix says:

    War is a racket. It always has been. It is possibly the oldest, easily the most profitable, surely the most vicious. It is the only one international in scope. It is the only one in which the profits are reckoned in dollars and the losses in lives. A racket is best described, I believe, as something that is not what it seems to the majority of the people. Only a small ‘inside’ group knows what it is about. It is conducted for the benefit of the very few, at the expense of the very many. Out of war a few people make huge fortunes.

    Butler confesses that during his decades of service in the United States Marine Corps:

    I helped make Mexico, especially Tampico, safe for American oil interests in 1914. I helped make Haiti and Cuba a decent place for the National City Bank boys to collect revenues in. I helped in the raping of half a dozen Central American republics for the benefits of Wall Street. The record of racketeering is long. I helped purify Nicaragua for the international banking house of Brown Brothers in 1909-1912 (where have I heard that name before?). I brought light to the Dominican Republic for American sugar interests in 1916. In China I helped see to it that Standard Oil went its way unmolested.

  7. Fast Eddie says:

    House of Saud to SloJo:

    Piss off you senile old man.

    The strategic reserve is umm… almost out of gas. Too bad slo joe couldn’t stretch it another month, it might have fooled a few more low information muppets into pulling the lever for the slight-of-hand dems. And then OPEC tells Jose Alvarez O’Biden that your party’s thirst for power is not our problem. Quick! Get that ab0rtion on demand campaign commercial ready!

  8. Chicago says:

    Those under 35 had no idea conditions were any other way.

    No One says:
    October 5, 2022 at 9:41 am
    Tough luck for those who imagined the Fed’s free money party would last forever.

  9. Libturd says:

    “Those under 35 had no idea conditions were any other way.”

    Which explains the massive growth in high risk investment (gambling?) vehicles which would have never seen the light of day before they were born.


    Give it some time. The bubble burst in late 2007. It did not valley out until late 2011. We are in the first inning. I got in just under the wire. The multi which went up recently by my old one just went under contract. Price should be a decent indicator of the local market. It’s very comparable to mine.

  10. 3b says:

    Lib: 20 odd houses in my town, most are in good locations, updated, don’t appear to be moving. And, starting to see price change notices on the listings; when was the last time we saw that?

  11. Fast Eddie says:

    Welcome To ParkLane Estates!

    Opening The Front Door You Become Enticed by the abundance of natural light given off from the oversized Luxury Velux 9’x7′ skylights…

    LOL. God help us. Another mess:–1150758397

  12. Phoenix says:

    America to Germany and Europe: You deserve this for tying your energy needs with Russia you dolts.

    Europe and Germany to Americans- yeah, and you dotards tie your energy needs to the Saudis. Eejits.

  13. leftwing says:


    Worth repeating, just be careful actually shorting shares into earnings…While rips up tend to be of less magnitude than the elevator down they can still be substantial. I rarely go directional into earnings, I will be setting positions for a credit and are only at risk outside of a two standard deviation move, or more…

    On indices and specific stocks…apologies if below is a stream of consciousness and open to discussing anything further. I’ve been balls deep the last couple weeks pulling apart stocks and the markets so this is fresh and unvarnished…

    Nominal > real…Lib, said this to you many months ago and noted at the time it was cryptic…inflation adjusted earnings don’t matter, if the nominal number is higher so is the stock. Sounds obvious, but the power of this statement should not be underestimated.

    Base effect. Company earnings will be subject to the same pathway I sketched out here for inflation…it’s fifth grade math, in a series of declining values if the first data point is substantially higher and falls out of series then the year over year trend will be down…third quarter last year was a tough one for many companies…the year over year earnings may compare favorably simply because of this effect…

    Unit growth and inflation…Revenue growth from inflation is masking declining unit growth and in some cases actual unit declines…I’m about half way through evaluating but hard line retail looks particularly affected…pre-covid every sector of retail had positive unit growth and total growth, some even while facing pricing declines. Now, for example, home furnishings revenue growth looks to be up about 7% so far this year but is comprised of 13% price inflation with a six percent decline on units…point is, be diligent. Declining unit volume in a disinflationary environment can kick the stool out from underneath forward guidance.

    Inventories….Can’t count the number of companies with inventory issues that run the gamut….I’m looking at those that have already announced and adjusted once (some have already had two go arounds…). I want to hear this quarter first before stepping in front of any of these stocks…I’ll look at those that have a second go-around this quarter, strong management, and obviously kitchen sink it.

    Services…exact opposite of the above. Still looking into wages but the acceleration in 3Q22 is likely less, and in some cases much less, than 3Q21…again, year over year base effect. Plus no inventory to fuck you over.

    The Bell Curve…said it here before, life is a bell curve. Regarding the markets I want my profits in the fat part and my risk in the tails. Certainly not vice versa…shorting CW shit-cos when they were four standard deviations up was easy…not clear to me where the risk is stepping in front of an unpredictable binary event, would seem that both the risk and return are in the fat part of the curve…which makes a straight short/long share position ahead of earnings a roll of the dice, no?

    Whisper Numbers and Multiples…whisper numbers on the SPX for 2023 are as low as 200…don’t underestimate how much downside is already priced in by market participants, although personally I could see it going to 175…Mutliples? JFC…so everyone is debating what multiple to apply to these discounted 2023 estimates, 15X, 16x, more, less? I’ve ripped apart the SPX in this regard, this analysis is a fools errand. Fact is the forward multiples of imploding earnings often explode into meaningless near term…number of reasons beyond the scope of here but I’m in process of two analyses on this data…will hopefully be done by 10/14 bank earnings and post thoughts but bottom line I would look through the year of recession or decline and to the following year (ie, 2024) to start to apply normalized market multiples. Based on history a truly conservative number would be 200 and a solid multiple of 16x yields my downside of 3200 off of 2024 numbers which occurs in 2H2023…I can work with that timeline (nine months) and downside here and now at 3700, through earnings especially if there are some good declines on quality companies.

    So what am I doing?….I’m a stock picker and it’s notable that recently I’ve added just as much if not more exposure in the indices than individual stocks…I have six or so watchlists that once drawn into the Venn diagram of Hell gives a focused list of names, both long and short.

    First and foremost I’m going to listen to the market over earnings and let it tell me what to do. I’m looking for a deal on the situations sketched out above but specifically not looking to dumpster dive behind a fast food joint. GARP services I’ll back up the truck. I want high quality financial companies, not money center banks but GS/MS or such. Real estate and housing has my eye as do certain sectors of healthcare. High quality companies with solid managements that kitchen sink a second go around of forward guidance are on the list.

    Big picture, to tie two of the above concepts together, we are closer to a bottom and once the all clear horn blows history shows this market is going to fly out of the gate. I certainly do NOT want to go short to try to time the last 15% or so down while missing the pop and long term upside…that is the definition of placing my return in the tail of the bell curve and my (opportunity) risk in the fat part, the exact opposite of how I make money. I want the companies I sketch out above at already discounted multiples to come off a bit, with or without company specific announcements, and make the buy there, now.

    Recall I am still substantially cash and the positions I do have mostly provide a skewed return (eg, 2:1 return to risk) with a buffer of no losses up to 10% down and more frequently 20% down. In other words my profile may not be yours and trade your own boundaries.


    Your Local HS Janitor

  14. Libturd says:


    That first house has a decent interior, which they seemed to have sacrificed the exterior for.

    That modern house looks really cool right now. Anything too contemporary looks silly and dates in a hurry. To sell it you have to wait until people consider it “retro.”

  15. No One says:

    Welcome to the residences at SoDoSoPa, bagholders

  16. Ex says:

    Montville Modern with the $13,500 tax bill.

  17. No One says:

    Or if your budget is tighter, welcome to CtPaTown

  18. Phoenix says:

    Is SoDoSoPa the same place as Hackensack aka “The Sack?”

  19. Libturd says:

    Thanks Leftwing.

    Definitely some good stuff in there. I don’t have the time to agree or refute all of your points, except for a couple which jump out at me.

    I appreciate the whack on the side of the head about the bell curve and risk reward. Don’t worry. Will not be going heavy.

    On the disagreement side, something’s gotta give with the healthcare providers. Our club’s best performers are Vertex and Molina. The whole medical-related sector seems immune to the economy. I quick look at the P/E of MOH shows it at 27. Five year average is 19. WTF?

    I also think there is a lot more downside than you believe (we’ve always debated this). I think we are in the middle of the 5th. Too many people are farting around right now. My friends spend all day on the internet when they are supposed to be working. I think this recession is going to be much deeper than most expect. Though, I agree a rapid comeback from the bottom as strangely, the FED will have the bullets to make it happen. This is why what they are doing is so important.

    Back to the urinals. Some pucks need replacing.

  20. leftwing says:

    “That first house has a decent interior, which they seemed to have sacrificed the exterior for.”

    Maybe…or the builder was blind. Or just getting rid of every leftover material from prior builds. Or the original owners so despised their soon-to-be new neighbors they intentionally put that up. Can you possibly imagine inviting a group of acquaintances over for a BBQ and have them see that monstrosity? I’d die of shame…

    “I hate central planners and central bankers so much. They are jerking people around, manipulating interest rates and the cost of credit to try to stimulate and depress people.”

    It’s even worse than you describe…after inflating the cost of everything the one cost they are solely focused on constraining as a measure of their ‘success’ is to suppress…people’s wages.

    Jack everything up in price then intentionally prevent people from making more…

    Downright evil.

  21. 3b says:

    Lib: A comeback from the bottom when the Fed is convinced they have inflation under control, and unfortunately that means pain. The talk about a Fed pivot is out there yet again, and the more that happens the more the Fed has to show they are serious. There will be no pivot anytime soon if by pivot that means lowering rates. They will stand still at some point, but that is after another hike in November, and probably December as well as thru have repeatedly said over the last few weeks.

  22. leftwing says:

    Haha, lol Lib.

    On healthcare not looking at providers…am looking at suppliers and servicers to big pharma like PKI for example or select CROs.

    Agree we can go down harder…after a lot of data crunching my biggest unexpected surprise was historically how SPX earnings play to recessions….I’ll see if I can dig up some links…Last year (2021) SPX earnings were 200, this year is tracking for about the same…all the discussion of analysts ‘taking 2023 down’ was off of forecasts for 2023, not off 2022 forecasts/actual…basically their near 20% down is taking a 250 forecast for 2023 down to 200…history does not show that, a more honest floor would be 20 down from 200 this year or 160 in 2023…market is definitely not priced for that and to me that is one of the biggest risks, both probability (meaningful) and magnitude (boom)…

    Either way, I think my worst case of 200 for 2024 (market starts pricing in nine months) is solidly conservative and with a 16x multiple gives me the hard downside of 3200 next summer…I can work with that on select long situations now, especially for quality companies that may come off on earnings, especially because of forward guidance.

    Do note the rip is real and occurs early…

  23. leftwing says:

    Although Lib I am rolling my timeline on trades out further. Previously said here I was anchoring to June 2023…ie, zooming out to the big picture and asking do I think we will be higher then than now? Previously answer was ‘yes’, now I’m applying the standard to December 2023 instead…

    Playing in TWTR…Equity with collar. All in cost of 51.20s, long puts at 50 short calls at 52. Risk/reward is gain of about 0.75 for risk of 1.25…the guy surrendered, deal has high probability of closing, I’ll take that risk and reward for a week or two on those terms.

    Also on SPX earnings in downturns…,ten%20recessions%20was%20%2D29.5%25.

  24. Fast Eddie says:


    That 1st house is an unwanted step child architecturally. Outside is hideous and when you walk in the front door, it’s a cavernous wasted warehouse. A total fail all around.

    The 2nd house will be built with standard Home Depot materials and talked up to be something special to justify the price tag. It’s a smash and grab.

  25. BRT says:

    heh, that happened a lot when I was shorting sh1tcos. There were 20% pops to the upside I was on the wrong side of. Fortunately, for sh1tcos, it’s always fake, and those moves were almost always erased a week or two later eventually followed by a drop to -70% off peak. Holding through the chop was a winner. But there’s no more meat on the bone for those plays. We saw non-profitable tech completely collapse without the same happening in the broad markets. But yeah, I don’t have the time right now to play individual companies, I’m swamped at work, which is why I’m just sticking to indexes to smooth out the noise.

    I think I’ve approached the point as to where I can stop trading and just design a portfolio for broad downturn. Probably just a combo of inverse SPY/QQQ/IWM/HYG and CDs/Blue chips on the the long side.

    My account is up 23% this year thanks to Crazy Cathie. Coulda been 40% if I went more aggressive. So, I accomplished my goal of beating inflation, now I just want to keep those gains.

  26. Ex says:

    12:05 cavernous wasted space. CA architecture in a nutshell .

  27. Ex says:

    11:17 whoa. That’s ridiculous.

  28. No One says:

    That Passaic Valley Rd house, wtf happened with boards in the slanted ceiling? It looks like they used to have skylights, then they replaced the roof and were too cheap to pay for replacement skylight windows, so now you get to see the back of two by fours and plywood holding up the roof? Ultimately, that house looks like a giant “lean to” shelter.

    I have a neighbor with a contemporary house with big slabs of wood wall with no eaves sheltering the wood from rain. Looks like it constantly is in need of repair and painting.

  29. Libturd says:

    It’s all of those randomly placed bay windows. Why did they put blinders on the front one? Maybe, so you wouldn’t see everyone sneering as they drove by? The whole house looks like a specialty window showroom. The best is this bay window over the deck (just why) with the view of the huge blank backwall of the garage. I’ll fix it.

  30. No One says:

    Lib, I’m talking about the thing in the ceiling on p30 out of 36.
    Nice photoshop.

  31. Fast Eddie says:

    That Passaic Valley Rd house, wtf happened with boards in the slanted ceiling?

    Nice feature, isn’t it? I think they took out those “Luxury Velux 9’x7′ skylights” in the 1st house I posted and plan to put it in the 2nd house I posted.

    What a chop job! I’m sure Mary Muppet won’t accept one dollar less than the asking price. Sellers in general are arrogant c0cksuckers. Sorry to use the term but it’s so true. I remember vividly putting two competitive offers in for houses only to be told the “sellers” were insulted. Don’t you know, both fucking houses were sold for almost the same price I offered. It was like a two grand difference each time. And I will also say most people can’t tastefully decorate a house at all. It doesn’t have to be high end stuff, just “eye” aesthetics is required. But no, color and style for some is dreadful.

  32. Fast Eddie says:

    I mean, even the bedroom furniture… wtf? A black lacquer something dresser and a Big Lots special next to it? Hello Ms. House Tour guide… get your shit together. Ugh.–2006027879?mid=16#lil-mediaTab

  33. Fast Eddie says:

    Look at slide 16 and 17, every piece of bedroom furniture is a mismatch.

  34. No One says:

    I think they were insulted because you offered them “$600k for your Chesterfield, cabbage, and Rhiengold reeking piece of shit cape, you fat muppet.

  35. Fast Eddie says:

    It’s chubby muppet, get it straight. Fat muppets have low metabolism, it’s genetic and not their fault. Chubby muppets are chubby by choice.

  36. chicagofinance says:

    I had the most interesting conversation with a client last week who imports wine at the wholesale level. I was talking about FX and how is cost line potentially could be coming down, but he refuted that thought vehemently. First he schooled me on the wine industry. The fucking liquid is only about 40% of the cost in his mind….. all the other stuff, glass, corks, printing etc. Then the actual process of getting trucks to the point of origin to the shippers. The to get into the shipping queue. He basically said that everything right now is fuct. There are 4 dozen ships waiting to get into Newark, when there normally should only be a backlog of just a few. All the inventory he has until the end of the year was ordered around Memorial Day.

    leftwing says:
    October 5, 2022 at 10:58 am
    Unit growth and inflation…Revenue growth from inflation is masking declining unit growth and in some cases actual unit declines…I’m about half way through evaluating but hard line retail looks particularly affected…pre-covid every sector of retail had positive unit growth and total growth, some even while facing pricing declines. Now, for example, home furnishings revenue growth looks to be up about 7% so far this year but is comprised of 13% price inflation with a six percent decline on units…point is, be diligent. Declining unit volume in a disinflationary environment can kick the stool out from underneath forward guidance.

  37. chicagofinance says:

    Going long vol right now isn’t so bad because it isnt elevated. I just dont like the decay in general. I always has a sinking feeling, but that is my blind spot. At least I know it.

    I agree on left’s fat belly of the distribution, but the problem is that the risk is skewed pretty badly. To simplify, we are in bear market conditions, so the chance of a face ripper are greater, because everyone is so bearish. Explains Monday/Tuesday. The other issue is people don’t believe Powell. You really want to go into Friday or CPI next week gambling on a binary?

    I am still for something……. maybe I’m waiting for Godot.

  38. No One says:

    Glass bottles use a lot of energy. So does transporting glass bottles. Time is becoming more costly as now interest rates are higher, so the cost of financing inventories is rising.

  39. chicagofinance says:

    Central banks are raising interest rates at the fastest pace in more than 40 years—and signs of stress are showing.

    Recent turmoil in British bond and currency markets is one. That disturbance has exposed potential risks lurking in pensions and government bond markets, which were relative oases of calm in past financial flare-ups.

    The Federal Reserve and other central banks are raising interest rates to beat back inflation by slowing economic growth. The risk, in addition to losses in wealth and household savings, is that increases can cause disruptions in lending, which swelled when rates were low.

    Major U.S. stock markets recorded their worst first nine months of a calendar year since 2002, before rallying this week. Treasury bonds, one of the world’s most widely held securities, have become harder to trade.

    There also are signs of strain in markets for corporate debt and concerns about emerging-market debt and energy products.

    Most analysts still don’t expect a repeat of the 2007-09 global financial crisis, citing reforms that have made the largest banks more resilient, new central bank tools and fewer indebted U.S. households.

    “So far there haven’t been any really bad surprises,” said William Dudley, former president of the Federal Reserve Bank of New York.

    Some pain is expected in the fight against inflation. Raising interest rates usually leads to lower stock prices, higher bond yields and a stronger dollar.

    Yet abrupt adjustments can lead to a slowdown more severe than what the Fed and other central banks want. Threats to financial stability sometimes spread from unexpected sources.

    “There are no immaculate tightening cycles,” said Mark Spindel, chief investment officer of MBB Capital Partners LLC in Washington. “Stuff breaks.”

    The current tightening follows years of short-term rates near zero and sometimes below. Historically, low rates encourage risk-taking, complacency, and leverage—the use of borrowed money to amplify profits and losses. In recent years, central banks also purchased trillions of dollars of government debt to hold down long-term rates.

    Low central bank rates were one reason that yields on corporate debt fell to less than 2% from about 6% between 2007 and 2021. During the same period, corporate debt ballooned to about half the size of the U.S. economy from 40% a decade ago. Yields shot higher this year, triggering unexpected losses.

    In one case, investment banks including Bank of America Corp., Credit Suisse Group AG and Goldman Sachs Group Inc. are on track to collectively lose more than $500 million on debt backing the leveraged buyout of Citrix Systems Inc. after it was sold to investors at a steep discount. Shares of Credit Suisse, which is restructuring to exit risky businesses, fell 18% over the past month while the cost of insuring its debt against default, as measured by credit-default swaps, soared.

    Meanwhile, the dollar has risen steeply against other currencies, threatening higher interest costs to emerging-market governments that borrowed heavily in recent years from foreign investors seeking higher returns. The foreign debt of low- and middle-income countries rose 6.9% last year to a record $9.3 trillion, according to World Bank estimates.

    Emerging-market governments have to repay roughly $86 billion in U.S. dollar bonds by the end of next year, according to data from Dealogic. A United Nations agency urged the Fed and other central banks Monday to halt rate increases, warning that “alarm bells are ringing most for developing countries, many of which are edging closer to debt default.”

    Pension pain
    Financial upheaval often happens in unexpected places, where bankers and regulators are unprepared or where they think markets are well-insulated.

    The turmoil in Britain involved pensions and government debts, long thought to be among the safest parts of the financial markets. The government on Sept. 23 announced a package of tax cuts that would have added significantly to deficits. In response, the pound sank to a record low against the dollar, and yields on British bonds, known as gilts, shot up.

    The rise in yields was amplified by derivative instruments loaded with hidden debt, part of a strategy by U.K. pension funds called “liability-driven investments,” or LDIs.

    Derivatives can be used to hedge risk or amplify returns. LDIs were designed to do both: protect pensions from low interest rates by constructing cheap hedges, while freeing up cash to invest in higher-yielding assets. British pension regulators encouraged plans to adopt LDI strategies despite signs that some had become dangerously exposed to interest-rate changes.

    As interest rates rose, pension funds were exposed to losses and margin calls, demands for cash to cover the risk of more losses. To cover margin calls, managers sold assets, in many cases even more gilts. The selling pushed interest rates higher, in a liquidation spiral.

    It had echoes of forced selling that figured in past crises, including the 1987 stock-market crash, the 1994 bond-market selloff that bankrupted Orange County, Calif., the 1998 Russia default and the 2007-09 global financial crisis.

    The Bank of England last week stepped in with a plan to buy gilts to relieve the pressure on pension funds. On Monday, the government backtracked and said it was dropping one of its planned tax cuts.

    Now, banks and governments around the world are grappling with how to interpret last week’s events. Some experts say the signs so far don’t point to disaster.

    U.S. corporate pension plans managed by consulting firm and insurance brokerage Willis Towers Watson have posted tens of millions of dollars in collateral to address margin calls this year, said portfolio manager John Delaney of Willis Towers Watson. But the strategy and the resulting margin calls are on a far smaller scale than in the U.K., where derivatives are more prevalent and pension plans tend to be bigger relative to company size, he said.

    Some U.S. public pension plans are vulnerable to margin calls. These plans used derivatives to substitute for bonds in their portfolio and increase the total amount they could invest to boost returns. The pensions adopted the strategy because low interest rates weren’t generating enough returns to pay promised benefits.


    Rate climb
    Central bank tightening is often behind financial disruption because of its effect on short-term interest rates. When those rates are low, investors will often borrow short-term funds to take on more risk for the prospect of higher returns. As rates rise, they have a harder time financing their positions.

    In 1994, the Fed surprised investors with a three-quarter percentage point rate increase to 5.5%. Financial managers for Orange County had investment positions that depended on low interest rates and the county went bankrupt.

    From 2004 to 2006, the Fed pushed up rates in quarter percentage point increments to 5.25% from 1%. Yet even that eventually undermined housing demand and prices, triggering a crisis among financial institutions that had invested heavily in mortgages and related products.

    The Fed and other central banks are now tightening much more aggressively than in past years because of high inflation. Since March, the Fed has raised its benchmark rate from near zero to more than 3% and signaled it will top 4% by year-end.

    The moves have pushed mortgage rates to their highest levels since 2007, raising concerns about a freeze in mortgage transactions and an even deeper downturn that chills demand for existing housing and new construction. But nothing on the scale of 2007-09 seems likely. U.S. mortgage debt has grown only 14% since 2007, most of it to much more creditworthy borrowers.

    More worrisome, economists say, is the 332% increase in outstanding Treasury debt during the same period, to $26.2 trillion.

    Like the U.K., the U.S. borrows in a currency it can also print. That means there is no risk of default, as there is with corporate, emerging-market or mortgage debt, the cause of many past crises. Printing currency to pay federal debt, however, risks causing more inflation.

    Bankers and regulators worry that Treasury debt is outgrowing Wall Street’s willingness or ability to trade in it. Inflation and Fed rate increases are adding to bond-market volatility, putting a strain on market functions.

    Banks designated by the Fed to transact in newly issued government securities, known as primary dealers, buy and sell with their own money to keep markets moving smoothly. The volume of Treasury debt held by these banks has shrunk to less than 1% of all outstanding Treasury debt, according to JPMorgan Chase & Co.

    This makes it more difficult for investors to buy or sell Treasurys with the volume, speed and at prices they have come to expect. That is a problem because of the market’s importance to the broader functioning of the credit system. In March 2020, for example, as the Fed was cutting short-term interest rates to help the economy, Treasury yields were rising, a result of unexpected selling by investors needing to raise cash as well as dysfunction in the market. The Fed stepped in and bought vast quantities of the debt.

    By one measure—how much debt can be traded at a given price—market functioning today is as bad as it was in April 2020, in the depth of pandemic lockdowns, according to JPMorgan. By another measure, this year has seen the worst conditions since 2010, according to Piper Sandler & Co.

    The morning after the Sept. 21 Fed meeting, Treasury yields shot up. The 10-year yield jumped to more than 3.7% from around 3.55% in less than two hours.

    Roberto Perli, a central bank expert at Piper Sandler noted a growing gap between the yields on the easily traded Treasurys and others, a sign of more difficult trading conditions. “The capacity of dealers to make orderly markets has diminished,” he said.

    Treasury officials said they don’t see a reason for alarm, but trading conditions are a problem they are watching. “Reduced market liquidity has served as a daily reminder that we need to be vigilant in monitoring market risks,” Nellie Liang, Treasury undersecretary for domestic finance, said last month.

    Two once-reliable sources of demand for Treasurys, banks and foreign investors, are pulling back.

    U.S. commercial banks increased their holdings of Treasury and agency securities other than mortgage bonds by nearly $750 billion over the course of 2020 and 2021, partly to invest a pandemic-induced surge in deposits. This year, as customers have shifted deposits to such alternatives as money-market funds, that figure has shrunk by about $70 billion since June.

    For years, Treasurys were among the few advanced-economy bond markets with positive yields, making them attractive to foreign investors and a haven during moments of market turmoil. Now, other government bonds’ yields are rising, giving foreign investors more options.

    Added to these strains, the Fed itself has stopped a bond-buying program launched during the pandemic to support markets and the economy.

    “We worry that in the Treasury market today, given its fragility, any type of large shock really runs the risk of un-anchoring Treasury yields,” said Mark Cabana, head of U.S. rates strategy at Bank of America.

    Heather Gillers contributed to this article.

  40. Grim says:

    Wage pressure for the US service sector is relentless.

  41. Juice Box says:

    I wondered why an Navy Osprey flew low over my house a little while ago…Pres Biden will be nearby at Gov Murphy’s house tomorrow for a DNC fundraiser.

Comments are closed.