The attached graph of CME Case Shiller futures on the HCI/CUS (10-city index) contracts during 2022 can be useful in illustrating several lessons on how users might interpret what the prices suggest.
1) During periods when home prices are expected to rise slowly over time, futures tend to be priced higher than the then spot index. This was the case in early 2022 when both the Feb '23 (G23) and Feb '24 (G24) contracts were quoted at higher levels than the spot index. Key to understanding this is that the index looks backwards as it is calculated on home transactions that have already taken place, while the futures contracts look (in part) to where index values will be at expiration of the contracts. Since the market "expects" home prices to rise over time the contract value for Feb '23 (which recall, references the index value as of Dec 2022) is higher than the index value of Dec 2021. Such one-year forward contract prices may be useful in seeing expectations of changes in the index over the one-year time horizon. (Note that this backward looking measurement is a feature of all home price indices, but is even more exaggerated for calculations on the Case Shiller index as there is a three month measurement window with a two month lag. That is the September index covers home closings that took place from May, June and July -all of which may have been negotiated even earlier).
2) Since the Feb '24 contract settles even further into the future, the price on the Feb '24 (G24) contract (all else the same) is even higher than the Feb '23 (G23) contract (e.g. the orange line is higher than blue line). The differences between these two contracts(or any expirations) are quoted as calendar spreads. For much of early 2022, the spread was quoted negative (i.e. the front contract trading at a discount the back contract. That is the calendar spread quotes were consistent with rising index values over 2023 (the difference between the two contracts).
3) Since the futures prices incorporate some element of forward expectations (as well as a healthy amount of traders willingness to add/reduce risk) they take into account all information. Since the quotes are live and actionable (even on small amounts) prices will change as: a) users buy and sell, and b) I adjust quotes to manage my risk (as I'm involved in the majority of trades). The market needs greater participation from more users to: a) become deeper, and b) to be less reflective of my positions, or the inquiries I'm managing.
4) Given that, the futures began to indicate a turn in the market during May 2022 when closes starting dropping. I'd note that since closes are "sticky" (in that it takes a lower trade or an offer below the last trade to result in a decline in contract prices), sentiment may have turned negative earlier. That is, offers on the Feb '23 contract may have been dropping throughout early May from 340 to 335 but it was not until there was a trade/offer at 330.6 on May 16th that the close for G23 fell. (The date of a lower close for G24 was May 11). (BTW -The trade of the year in this space was one personal financial manager getting his client to sell about $600k (notional value) of Feb 2024 exposures. That position could be unwound today for about a $160k profit!)
5) As prices fell, and concerns about how far forward indices might fall, the G23/G24 price relationship began to flatten, then inverted in late June (flipping from negative to positive), and continued to widen during the fall, consistent with index values declining during 2023.
6) As noted above, the spot index didn't drop until the Sept 26th release of the July index. The difference between that spot price (327.76) and the Aug 2023 contract price (not shown) of ~295, was the support for Robert Shiller's observation at the time, that the contracts were prices for a greater than 10% decline in the index over the next 12 months. The difference between the spot and Feb 2024 index is inconsistent with even further declines.
7) Since the Feb 2023 contract will settle on the index value released on Feb 28, 2023, the G23 contract price and index value will converge. (Note the gap between blue line and black line is compressing and should drive toward zero at expiration). While no one know the index value to be released that date, all of the home transactions that will be included in that index have already closed (by Dec 31) so changes to home price expectations ( e.g. a 100 bps rise/fall in mortgage rates in January 2023) should have no impact on Feb 2023 contract. That is, I'd expect trading in the Feb 2023 contract to be dominated by users debating the final index value, while the Feb 2024 contract will still have an element of users looking to transfer risk. This is why, since October, I've been trying to steer users to consider the Feb 2024 contract as the benchmark expiration.
8) I'd note that, given limited volume over time ( I estimate that ~188 contracts traded during 2022), that there are more natural sellers (hedgers) participating here, than natural buyers (with speculators making up the difference). This, I believe, has the effect of driving clearing levels to below expectations. This imbalance probably weighs more heaving on intermediate expiration contracts (e.g. Feb 2024-Feb 2025) as I get many more hedging inquiries (from individuals) for that timeframe, than from institutional buyers (as volume is too low to justify their participation). However, I am hopeful that discount, combined with the ability to buy exposure to home price levels from Aug 2021 (~273) for the Feb 2024 and Feb 2025 (not shown) contracts might prove enticing to some institutional buyer.
The graph shows a small uptick in the Feb 2024 contract prices during late December. I don't know whether this is a change in outlook (e.g. mortgage rates coming down), a reduction in the fear that home prices will collapse (given continued lack of inventory), simply that I pushed prices lower (too far?) to find clearing levels, or just noise (given low volume, and that I was traveling overseas). Volume tends to spike when expectations change, as people with newer view (or perceived needs to add/ reduce exposure) cross paths with those anchored in the recent trend. Might we see that in early 2023?
This market could use your help, and as such, I would ask users to focus on the HCIG24 (Feb 2024) contracts (as opposed to spreading inquires out over the 98 other contracts - 11 regions * 9 expirations/ region). Prices in other regions, or for other expirations can then be separately negotiated via InterCIty and Calendar spreads -both of which are more stable -to create prices for other contracts. Consider taking a one lot position to beta-test your platforms, so that when you're ready to buy/sell more, or when sellers/ buyers show up, you're be ready to dive in. That said, I continue to be willing to quote any region/expiration, but the liquidity will likely be best in the Feb 24 contracts. I'm open to sharing graphs from the other regions (with Chicago being more stable, and San Fran being more volatile) but my early focus for 2023 is here. (FYI 97% of the Open Interest is in the Feb expiration cycle contracts, and 56% of the trades done in 2022 were in the HCI contract, with the 10 regional contracts sharing the remaining 44%).
Thanks, and a happy, health New Year to all.
John