North - South Korea Conflict = Lower Rates

Heightened International Tension Strengthens Dollar

The conflict between North and South Korea is having a predictable effect on credit markets this morning.

Specifically, whenever international tensions kick up, there is a flight to safety, which -- at least until now -- translates into demand for U.S. dollars and U.S. debt.

That strengthens the dollar, and (also) drives interest rates lower, however temporarily.

All Roads Lead to -- and from -- the U.S. Dollar

U.S. Dollar Down, Everything Else . . Up!

Perplexed by the action in stocks and commodities since last Spring? (I've addressed housing in many, many other posts.)

See the explanation (below), courtesy of David Rosenberg, chief economist and strategist at Toronto-based investment manager Gluskin Sheff.

It's a bit wonky -- note the references to the DXY, VIX, various credit spreads, etc. -- but very worthwhile.

The reader's digest version?

As the dollar declines . . . it's driving up everything else.

The U.S. dollar . . . has become a huge ‘carry trade’ vehicle for all risky assets. Historically, there is no correlation at all between the DXY index (the U.S. dollar index) and the S&P 500. In the past eight months, that correlation is 90%. Ditto for credit spreads — zero correlation from 1995 to 2008, but now it has surged to 90% since April. There was historically a 70% inverse correlation between the U.S. dollar and emerging markets, such as the Brazilian Bovespa, and that correlation has also increased to 90% since the spring. Even the VIX index, which historically has had no better than a 20% correlation with the U.S. dollar, has now sent that correlation surge to 90%. Amazing. The inverse correlations between the U.S. dollar and gold and the U.S. dollar and commodities were always strong, but these too have strengthened and now stand at over 90%.

--David Rosenberg, "Breakfast with Dave" (11/19/09)

I consider my financial vocabulary to be pretty extensive, but I've seen so many references to the DXY the last few weeks that I finally googled it to find out.

It turns out to be a basket of six, non-U.S. currencies that reflects the strength/weakness of the dollar.

If you read the above excerpt, you know which way it's been going.

Real Estate & Inflation -- Updated

A *Macroeconomic Overview

Back in April, I ran a post called "Real Estate & Inflation" that isolated wage growth as the key to whether any inflationary outbreak would help or hurt real estate (incidentally, that post is now ranked 18th in the world, according to Google).

Specifically, if inflation spilled over into workers' wages, it would drive up real estate; absent that, inflation would hurt real estate.

That's because static wages plus rising prices for everything else (food, gas, health care, etc.) would "crowd out" consumers' ability to spend on housing.

Six months later, how do things look?

Clearly, there is no inflationary pressure on wages. In fact, with unemployment at about 10% nationally and still rising, there is more downward pressure on wages than upward.

However . . . two other developments have come into clearer focus.

Coming Into Focus

The first is the Fed's apparently indefinite commitment to an easy (free?) money policy -- at least to banks that borrow from it.

Second, while wage inflation is nowhere to be found, asset and commodity inflation -- at least outside of housing -- appears to be rampant. (Hmmm . . . maybe the two are linked).

The Dow Jones is well over 10,000, gold smashed through 1,000 an ounce weeks ago, and oil appears to be poised for another run at $100 (and beyond). Meanwhile, the dollar is plumbing record lows against the Euro, yen, and other major currencies.

So, to return to the original question, what will an outbreak of inflation mean for real estate -- and specifically, the housing market?

Based on the foregoing, I've shifted into the camp that believes that rising inflation elsewhere in the economy will ultimately spill over into real estate, as well -- even if wage growth is flat (or negative).

If the economy can simultaneously experience recession and inflation -- a phenomenon dubbed "stagflation" in the '70's -- there's no reason why houses can't appreciate in a lousy economy, given what's happening to other asset prices.

P.S.: Peter Lynch has a famous line that if you spend 15 minutes a year trying to figure out macroeconomic factors . . . you've wasted 13 minutes.