Lumber, jacked | Financial Times

This, as you will remember, is the week Unhedged does not talk about inflation. Today, for example, we are talking about bottlenecks in a key supply chain. A bottleneck is a thing that makes you think there is inflation when really there isn’t any, which is very different. 

Email me: Robert.Armstrong@ft.com

Tiiimmmberrrrrrrrrr!

Or, rather, Luuummmberrrrr!

Here’s some data from Bloomberg:

Rising lumber prices have been everyone’s favourite example of what results from clogged pandemic supply chains and the booming post-virus economy. They left other fast-rising commodities prices in their (saw)dust. Production and distribution of lumber were hobbled by the virus, even as demand held strong due to a boom in lockdown home improvement projects. House building boomed as the US opened up. Lumber shot up, pushing house prices up with them, and raising anxieties about the economy’s ability to return to normal. 

But things have started to revert to normal — fast. Lumber futures, pictured above, have given up half their pandemic gains in just a few weeks. This is from a Bloomberg story a couple of days ago: 

“Sawmills appear to be catching up with the rampant home building demand . . . buyers are baulking at still historically elevated prices and awaiting additional supplies, setting off a cascading sell-off, analysts said.

‘“Activity yesterday was brisk to start, turned lethargic and ended quite subdued,’ William Giguere, who buys and sells eastern spruce with mills for Sherwood Lumber in Massachusetts, said in a note [on] Friday. ‘There was plenty of lumber available from the mills and enough ambition to sell. Missing was the sense of urgency from buyers.’”

The demand/supply imbalance has started to correct. But as the chart shows, prices are still at a multiple of historically normal levels. It is still an open question whether the pandemic, or some other change in the economy, has altered the supply/demand balance in a sustained way. 

I asked Paul Jannke, lumber principal at the consultancy Forest Economic Advisors, about this. Supply was disrupted not only by the virus, he said, but by very cold weather in February in parts of the US south-east, where much of the country’s timber is cut. Demand was strong because there was little for consumers to spend their money on but home improvement.

At the top of the market, though, that demand went mostly unmet. When prices got up near $1,600, very little lumber was sold, Jannke said. There was little to be had and even fewer buyers willing to pay up. The tip of the spike in prices was an artefact of a moment of extreme market thinness. 

Now, he says, both sides of the supply/demand equation are normalising. Supply chains are back, consumers have other things to spend their money on, and the high lumber prices have led many DIY-ers to put off projects.

Mark Wilde, forest products analyst at BMO Capital Markets, thinks that the drop-off in home improvement spending is particularly important to the fall in prices. The prices of the wood panels that are used as the substrates for walls and ceilings in residential construction have held up. It’s the two-by-fours and other stuff of decks and home improvement projects that have plummeted. He said he talked to one private lumber supplier who said that orders from a big chain of DIY stores were off by half from the peak. 

Residential construction is still hot, but has cooled somewhat, mostly because high prices are turning buyers off. The National Association of Homebuilders Market Index, which tracks housing market conditions based on surveys of homebuilders, hit its lowest level in 10 months this week. The NAHB chief economist said rising prices, driven by higher labour and materials costs, “are pushing some buyers to the sidelines”.

Here, from Pantheon Macroeconomics, is a chart showing the NAHB’s buyer traffic index (survey data on how many shoppers are looking for newly built homes) and the Mortgage Bankers Association index of purchase mortgage application volumes. They are flat-to-down and turning over, respectively:

Why should we financial markets people care about all this? Because the spike in lumber prices, this year’s poster child for commodity price increases, looks like an Covid-specific phenomenon that is now abating, rather than the result of the fiscal and monetary policies that have people worried about persistent inflation. 

(I admit it! I’ve been talking about inflation this whole time! I just couldn’t help myself!)

Yes, low interest rates have spurred home buying, but people moving out of cities and into the suburbs and countryside is part of that story, too. And a lot of the lumber demand spike was DIY projects by bored homeowners stuck at home. That’s ending. On the supply side, the impact of the virus and the cold winter are receding fast too. The lumber price spike was driven by an exogenous shock and it looks like it is resolving itself in just the way one would hope. We can hope other price spikes will start to correct, too. Everyone calm down.

There is one longer-term reason to expect higher lumber prices, though. Both Jannke and Wilde think that lumber prices, while very unlikely to hang around $1,000 for long, should stay above historical averages for some years to come. This is because since the financial crisis, the US has not built enough houses to keep pace with the population, and it will have to catch up:

The reason I mention this is that high house prices right now have something to do with low rates and stimulus cheques and so on, but they also have to do with there not being enough houses. There are not enough houses because one legacy of the housing bubble was a decade of under-investment in housing. When we talk about inflation, we need to talk about policy. But we should probably start talking about low rates of investment, too.

One more thought about the dollar and then I will shut up about it, I promise

In yesterday’s piece about trade deficits, capital surpluses and the dollar, I took up Michael Pettis view that America’s trade deficit is caused by its capital account surplus, not the other way around. Capital desperately wants into America, and into dollar assets. That capital finds its way back “out” of the country as a trade deficit, ensuring the two accounts balance, as they must. This is a hard view to wrap one’s head around, but my colleague Brendan Greeley emailed with a good way to think about it:

I think of dollar creation in America as a product. Equity markets, real estate, Treasuries, anything securitised — there’s such massive demand for any asset denominated in dollars that we create dollars as a product to meet this demand . . . just like oil economies are distorted to prize the production of oil over everything else, the American economy is distorted around the need to create financial assets denominated in dollars. 

Read Brendan’s full case for this idea here. I think this mad demand for dollar assets results largely from excess savings in other countries, but also reflects the dollar’s “exorbitant privilege” as the world’s reserve currency and currency of trade. I recommend again John Plender’s recent account of threats to that privilege. But one reader suggested a threat John did not consider: international ire at America’s use of its currency as a geopolitical bludgeon.

Caleb Johnson of Harbor Macro Strategies wrote: 

In the early 2000s . . . we learned how targeted sanctions could permit America to fight wars less violently . . . We may have learned this lesson too well. Over-enamoured with sanctions, we have deployed them so much that America’s adversaries are increasingly aligning around the need to transact more in other currencies. You’re seeing this with Russia’s recent move to sell off dollars from its reserve fund and more aggressively push Russian companies to transact in euros wherever possible. And you’re seeing it elsewhere with even small central banks experimenting with digital currencies.

I’m not sure how big a deal this is, but thinking about the dollar in terms of geopolitical rivalries is probably a good idea. 

One good read

I’m not sure how I missed this guide to being a sellside economist, put out by the research shop TS Lombard last year. It is hilarious. As a chart person, I smiled only somewhat bitterly at this truth bomb:

Mastering chartism: it is possible to show a relationship between almost any two variables in macroeconomics as long as you can display them on two axes and are willing to spend enough time manipulating the second axis, experimenting with data lags, inversions or various moving averages. If you still can’t make the relationship work, extend your history to cover the global financial crisis; everything looks correlated during the GFC.