Sunday, March 22, 2015

The Continuing Land Price Decline

A recent article on summarizes a couple of the causes of the continuing slump in land prices. In this post I'll expand a little bit on the article and discuss some possible scenarios going forward.

As the article indicates, the recent strength in the dollar has put downward pressure on crop prices (and, of course, oil). Part of this is due to an expected decline in exports. As the dollar strengthens, foreign buyers of US commodities will have to pay more in terms of their own currencies to purchase US products. If we expect crop prices to be low, we would expect land prices to fall especially if we expect interest rates to rise (For a full discussion of this issue, see this article.)

Over the last week, the financial press has been abuzz with news of the Fed's removal of the term "patient" from its guidance. The question was whether the Fed would remain "patient" and put off raising its federal funds interest rate target. Since asset prices are an inverse function of interest rates, an indication that rates would rise sooner would probably have pushed down the major stock indices.

While the word "patient" was removed, Fed Chair Janet Yellen's other comments were enough to assuage fears of an imminent rate hike and the major stock market indices surged. In fact, CME's FedWatch no longer predicts a greater than 50% chance of a rate hike for September. October is now the earliest month we can expect a greater than 50% chance of a rate hike (67% as of today). The probability of a rate hike doesn't cross 90% until March of next year.

So if expectations of higher interest rates in coming months are low, why has the dollar risen so much since last August? One major reason is the end of QE3. Another reason is that other central banks of major economies including Japan, China, and the EU, have either cut interest rates or have promised to do so. These rate cuts imply an expansion of their respective money supplies and a devaluation of their currencies. Apparently the market expects their currency devaluation to be more extreme than that of the US, resulting in a stronger dollar relative to the yuan, yen, and euro.

There are a few possible scenarios that could play out here. The Fed could push for more devaluation of the dollar by promising not to hike rates (or launch QE4), resulting in upward pressure on commodities. This pressure may slow or even reverse the decline in land values. Economic indicators such as unemployment, GDP growth, and consumer price inflation could strengthen, pressuring the Fed to raise rates. This would be bearish for commodities and would likely perpetuate the decline in land values. A third possibility is that other world governments continue to devalue their currencies and the Fed stays its current course, creating substantial uncertainty as to which direction the dollar and interest rates will go. If the third possibility is realized, I would expect land values to continue to decline.

It's difficult to say which of the three scenarios I've laid out is the most likely to occur. The best bet is probably that the Fed will continue to him and haw about rate hikes over the next few months but will eventually have to promise to keep rates low and launch another round of QE. The latter will be "necessary" to keep long-term rates down. While I personally don't advocate this course of action, when push comes to shove, I think this is the most likely scenario. Will land values recover? Not in the long run. We have a land value bubble that is in need of a substantial correction. In the short run, however, my prediction is that the Fed will do what it can to keep all asset prices up, so don't expect a dramatic drop in land prices over the next several months.

No comments:

Post a Comment