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Why the Fed can’t save housing

Talking Numbers

Talk of Fed tapering raised mortgage rates. But, even though tapering hasn't happened yet, home builder stocks are down. Is there hope ahead?

One of the most important sectors in the economy may have trouble ahead and it could all be the Federal Reserve Bank's fault. And, it could have negative repercussions for home builder stocks, which are down 11% over the last six months.

According to the Mortgage Bankers Association's mortgage index, applications for purchase mortgages and refinancing dropped 7% last week on a seasonally-adjusted basis. The week before that, it was up 6.4%. For the entire month of October, the MBA mortgage index was up nearly 8% but it's still about where it was in August. Nonetheless, mortgages applications are about 46% less than they were in April.

Tied into mortgage applications, of course, are mortgage rates. They've gone up considerably since May, when a 30-year fixed mortgage was averaging about 3.53%. By October, they were 4.09%. That's still lower than September's 4.48%, but it means $32 more every month in mortgage payments for every $100,000 borrowed compared to May. And, it means some homeowners are also priced out of some homes they previously could afford.

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The rise in mortgage rates was in large part due to the massive bond selloff that began in May. Since the start of the financial crisis half a decade ago, the Fed has been buying US Treasury and mortgage bonds in the markets. That adds dollars into the system and it also lowers interest rates since higher bond prices leads to lower bond yields.

Since December, the Fed has been buying bonds at a rate of $85 billion per month but in May, Fed Chairman Ben Bernanke hinted a potential tapering. Investors dumped bonds anticipating the largest buyer would be out of the market by September. In the end, the Fed decided against tapering but yields on the benchmark 10-year US bond went from 1.63% in May to 2.98% in September. Yields have come down a bit to 2.64% but they're roughly where they were in August.

Higher rates have an effect on at least one sector of the economy: home builders. The iShares U.S. Home Construction ETF (the ITB), has dropped 11% in the last six months as rates moved up. Comprised of some of the industry's biggest names (Pulte, Lennar, DR Horton, Toll Brothers, and NVR make up 45%), this ETF gives a good indication of how home builders are doing. For the last half of a year, it hasn't been so great. But, it may not last.

"We've had four straight months of slowing in mortgage applications," says CNBC contributor Gina Sanchez, founder of Chantico Global. "However, there is still demand in the market. If you look at interest rates, even though they are rising, they're still low historically. And, rental rates are rising such that people are starting to look more and more at housing [purchases] as an option [compared] to renting."

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"When you look at this sector as a whole, it's kind of curious," says Talking Numbers contributor Richard Ross, Global Technical Strategist at Auerbach Grayson. "Home builders [are] almost countercyclical in nature. This is really an early cycle group and here we are, very late in the cycle. By that I mean they have been viewed historically somewhat defensively."

An anticipated improvement in the economy led to a rise in home builder stocks. But, that changed earlier this year.

"From the low in 2011 until May of this year, [home builders climbed] 220% while the S&P [was] up only 50%," says Ross. "Now you see since that peak, down 15% on the home builders and the S&P has continued to move higher. That's what you would expect to see late in the cycle."

Ross sees the ITB at a critical point right now as it tests a key resistance level. Failure to break above it would make Ross a seller.

To see what level Ross is looking for and to hear more of Sanchez's analysis of the housing market, watch the video above.

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