What I see for 2022: Interest rates, mortgage rates, real estate, equities and other assets as central banks face fierce inflation

An extra special cocktail of three powerful ingredients without cherries on top awaits us in 2022.

By Wolf Richter for WOLF STREET.

Super inflated asset prices such as homes, stocks and bonds; massive inflation; and central banks that have begun to react.

Many central banks have begun to push up interest rates; others have completed the purchase of assets. And Quantitative Tightening (QT) – central banks throwing away assets – is on the table.

Rising US interest rates will not catch up with furious inflation in 2022 – CPI inflation is now 6.8%, the highest in 40 years.

But unlike 40 years ago, inflation is now on the rise. In the early 1980s, it began to decline. We must compare the current situation with the 1[ads1]970s, when inflation rose higher. So we are entering a new environment where the economy will do things we have not seen in decades. It will be a new ball game for just about everyone.

As always, inflation figures will fluctuate from year to year. The CPI can go above 7% or 8% and then fall back to 5% only to jump again, giving moments of false hopes – as they did during the inflationary waves of the 1970s – only to race even higher.

Inflation has now spread deep into the economy, with service inflation picking up, and there are no bottlenecks in the supply chain involved. This includes the inflation targets for housing costs. These housing inflation measures have begun to rise.

We know that the figures for housing inflation, which make up about a third of the total CPI, will rise further in 2022, based on housing data that we saw in 2021, and which is now slowly being taken up by the inflation indices. They started going higher in mid-2021 from very low levels, and they are going to be red hot in 2022.

This is because inflation is driven by huge monetary and fiscal stimulus, globally, but especially in the United States – with nearly $ 5 trillion in money pressure since March 2020, and over $ 5 trillion in government spending on borrowed money.

The stimulus has broken the price resistance among companies and consumers. Enough companies and consumers are willing to pay even the craziest prices – a sign that inflation thinking has taken over for the first time in decades. All this stimulus has broken the dam.

Inflation will not disappear until central banks remove fuel via QT to raise long-term interest rates, and by pushing up short-term interest rates via rate hikes, and until these policies are drastic enough to shut down inflation thinking and restore price resistance among businesses and consumers.

Central banks around the world are responding.

Bank of Japan ended QE in May 2021 – the longest money printer has stopped printing money.

The Fed began to downgrade QE in November and doubled the rate of downgrading in December. If it does not accelerate further, QE will end in March.

The Bank of Canada closed QE in October. The Bank of England closed QE in December. The ECB announced that it would halve the huge QE program by March. Several smaller central banks that did QE have closed it.

Central banks in developed markets have already raised interest rates:

• Bank of England: with 15 basis points, in December, for relocation.
• National Bank of Poland: three increases, a total of 165 basis points, to 1.75%.
• Czech National Bank: five times with a total of 350 basis points, to 3.75%.
• Norges Bank: for the second time, with a total of 50 basis points, to 0.5%.
• Hungarian National Bank: many small increases of a total of 180 basis points, to 2.4%.
• Bank of Korea: twice, with 50 basis points in total, at 1.0%.
• Reserve Bank of New Zealand: twice, with 50 basis points in total, at 0.75%.
• Central Bank of Iceland: four times, with 125 basis points in total, to 2.0%.

Central banks in emerging markets have been much more aggressive in raising interest rates to control inflation and protect their currencies; a plunge in their currencies would make dollar financing very difficult. They are trying to stay well ahead of the Fed. Among them:

• Central Bank of Russia: seven times, a total of 425 basis points, to 8.5%.
• Bank of Brazil: several huge interest rate hikes, with 725 basis points since March, to 9.25%.
• Bank of the Republic (Colombia): three increases of a total of 125 basis points, to 3.0%.
• Bank of Mexico: five increases, a total of 150 basis points, to 5.5%.
• Central Bank of Chile: four increases, 350 basis points in total, to 4.0%.
• State Bank of Pakistan: three increases, a total of 275 basis points, to 9.75%.
• Armenia’s central bank: seven increases, a total of 350 basis points, to 7.75%.
• Central Reserve Bank of Peru: five increases, a total of 225 basis points, to 2.5%.

There are some exceptions, especially Turkey, which has embarked on an all-out attempt to devalue its currency via inflation and succeeds in doing so by cutting interest rates. During the year 2021, the lira has collapsed by almost 80% against the dollar, with inflation above 20%.

But in the United States in my lifetime, there has never been a toxic combination of interest rate repression to close to 0%, in the middle of inflation of 6.8%, as the Fed’s money printing continues until further notice.

In 2022, the Fed will begin to phase out this phenomenon much faster than expected months ago.

Long-term interest rates may not move much higher until the Fed ends its QE program, which was designed to suppress interest rates. The end of QE is scheduled for March.

Beyond that, long-term interest rates can not really rise until the Fed’s balance sheet falls. This happens when the Fed allows maturing securities to roll off without compensation. At the last meeting, Powell informed the markets that the Fed is now discussing QT.

At every Fed meeting, the process has accelerated. During the last meetings, the Fed proposals went from no interest rate increases in 2022, to three increases in December. It went from not even discussing the end of QE to speeding up the end of QE. And it went from QT was unthinkable in 2022, to it was already discussed in December 2021. The Fed is preparing the markets for these changes.

And this trend of speeding up the process is likely to continue in 2022.

Last time, the entire procedure took four years: From the start of the reduction of QE in early 2014 to significant QT and several interest rate increases in 2018.

This time, the whole process from the beginning of downsizing (November 2021) to significant QT and several interest rate increases can take a year.

Significant QT will allow long-term interest rates to move higher, thus keeping the yield curve steep enough when the Fed raises short-term interest rates.

The reason the Fed will move faster in 2022 is this furious inflation. Back in 2014 to 2016, the oil price collapsed from over $ 100 a barrel for WTI to below $ 30 a barrel, which pushed inflation down, and there was no inflationary pressure. The Fed just wanted to normalize monetary policy. Now inflation is plummeting, and the Fed must tighten. With a lot. And some of this will start in 2022.

What will higher interest rates mean for the property.

Normally, in the initial phases of rising mortgage rates, there is a mini-wave in purchases as homebuyers want to lock in the lower mortgage rates before rising further. But when mortgage rates reach a certain magic level, home sales begin to soar, as buyers can no longer afford to pay the higher mortgage rates and sky-high prices. Something must be given for the sale to take place: Price cut.

This situation began to play out in 2018, especially later in the year, when the 30-year fixed interest rates on mortgages approached 5%. Somewhere above 4% was the magic rate in 2018 where the market began to fluctuate. At that time, the shares also sold strongly.

But in 2018, there was not much inflation, and the Fed could justify withdrawing. Now, in 2022, there is furious inflation. And bonds spearheaded.

This time it is very different: house prices have skyrocketed – up almost 20% year-on-year for the US as a whole, according to the Case Shiller Index, and by 30% year-over-year in some markets.

So the classic behavior of buyers jumping into the market when they see rising mortgage rates on the horizon may not be happening to the extent that it happened before.

When mortgage rates reach the magic level, which may be lower than last time given today’s sky-high prices, the volume will weaken. For more sales to take place, prices must go down. This starts the cycle.

Lower mortgage rates lead to house price growth. Higher mortgage rates do the opposite – they will eventually cool the housing market. The decline in the housing market is slow and can take many years. So in 2022, we may see the first frightening start in selected markets.

Other real estate markets are also involved. For example, in the early 1980s, when interest rates were raised to curb inflation, the agricultural agricultural bubble burst, and agricultural land values ​​plunged by more than 50% in some Midwest regions from 1981 to 1985. Overvalued agricultural land had been used as collateral for loans issued by specialized banks, and when these loans became bad, some of these banks collapsed.

So in 2004, the Fed began to raise interest rates, eventually rising from 1% to over 5% in mid-2006. .

It is not always clear in advance what will cool down when long-term interest rates rise far enough in a congested market. But one thing is clear: some things are cooling down.

The last time we had this inflation was 40 to 50 years ago, but by then interest rates were already much higher.

In 1973, when inflation began to rise, mortgage rates moved north of 8%. In 1979, it exceeded 10%. At the beginning of the 1980s, 30-year fixed-rate mortgage rates were over 15%.

But we can not really compare the situation in 2022 and beyond with the situation 50 years ago, because for much of the time since 2008 we have had massively suppressed interest rates, massively inflated real estate prices and massively inflated asset prices across the board. . Financial repression prevails, with “real” short-term interest rates all the way up to junk bonds are negative. It just has not happened before in my life.

When it comes to the housing market, there are unpleasant parallels with 2005: Investors are heavily involved; and there are many loans with low repayment, guaranteed by FHA and other government agencies, with repayments as low as 3%. These agencies have also guaranteed many mortgages issued to subprime borrowers.

But this time, the taxpayer is most on the hook for those mortgages, not the banks, when the market turns south. So a financial crisis of that kind in 2008 is not what I see because the banks have sloughed off much of the risk for taxpayers.

What I see is just the beginning of a decline in property prices, including housing – but not a collapse of the banking system.

The Fed, now that it has this gigantic balance, has a huge tool in its toolbox that it did not have 40 years ago: trillions of dollars in bonds that it can roll out or sell directly to drive up long-term interest rates without even having to Raise short-term interest rates so much. It is long-term interest rates that matter most, and QT is designed to push them up, just as QE was designed to push them down.

And just as QE inflated markets since 2008, with only a mild boost to the real economy, when QT slows down markets and asset prices, it will only have a relatively mild impact on the real economy. And that economy is so overstimulated that letting some of the hot air out would be a good thing – and that’s probably what the Fed is after. If it is large enough and lasts long enough, it may even curb inflation in the years to come.

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