Today (Friday May 24th) is the last trading day for the May '19 (K19) Case Shiller home price futures (as markets are closed on Memorial Day). A reminder, that while trading is open until 4 PM (Eastern) the front contract typically stops trading an hour earlier.
With the May contract expiring it's a good time to review (for explain for new readers) the notion of convergence and the possible implications for Tuesday's headlines.
The graph below illustrates how futures and spot index levels converge near expiration. That is, since the CME home price index contracts settle on the value of the Case Shiller indices announced on the last Tuesday of the expiration month, contact prices should move toward, and in theory, bracket expectations for those indices. In actuality, contract prices have been above spot index levels for most of the last 2+ years, consistent with expectations of further increases in the then-spot rate. This has been the case since 2012 without interruption -except this past winter - when some longer-dated forward curves went inverted (most notably SFR). However, since the Fed decision to leave rates unchanged in March, both spot and May '19 contract prices have been in sync with each other, while longer-dated contracts have resumed their premium to spot.
Given that the contract prices move toward expected index values what might be inferred from recent May '19 contract prices?
The table below shows the bid, ask, and mid-market value for the 10-city index contract (HCI here, but CUS on some systems) as well as quotes for each of the ten component cities. It'd note:
1) The bid/ask spreads are wider than average for a contract with one month to go, much less with one day.
2) Most of the bids and offerings are mine. These two comments are related in that I will often post a ~2-point bid/ask spread on expiring contracts, but those with stronger views will often bid above me, or offer below, narrowing the bid/ask spread. There's been very limited activity this month of that nature. Trading volume has fallen off abruptly from the 42 contracts that traded in March (to 3 MTD) and evidence of other traders' interest has been low. As such, readers should be cautious in how strongly they embrace the next points.
3) Given the above, the mid-market levels suggest that Tuesday headlines will tout:
"HPA (Home Price Appreciation) continued but at slower rates"
"LAV (Las Vegas) was the strongest performing region, of the ten listed CME contracts", and possibly that
"SFR index values fell -on an annual basis -for the first time since 2012"
The convergence of contract prices and indices does not mean that today's quotes will bracket all of Tuesday's numbers. In fact there have been quarters over the last seven years (recall that contracts expire on a Feb., May, Aug., Nov. cycle) where contract prices "correctly" bracketed index numbers as few as 4 times and as many as 11. While index revisions (most notably in the NYM and WDC regions) may explain why some contract prices fail to forecast index results, it may also be either that indices are difficult to forecast, that the people doing so with their bids and offers (so this month, as of last night, mostly me) don't have the tools to make proper forecasts, or that those that can make forecasts opt not to participate.
I'll revisit this blog and these numbers after the Tuesday Case Shiller release. in the meantime feel free to contact me if you have any questions about this blog or any aspect of hedging home price indices.
Thanks, john