Goldman SachsThe U.S. housing recovery has been one of the most encouraging economic stories in the world since the financial crisis.
However, mortgage rates have been on the rise, and recent housing data have been raising red flags.
"A number of housing indicators―including new home sales, housing starts, and new purchase mortgage applications―have softened in recent months relative to their trend over the past year," wrote Goldman Sachs' Kris Dawsey and Marty Young in a note to clients on Monday. All of this is illustrated in Goldman's proprietary housing sector current activity indicator (CAI), an aggregation of various housing market series, which has turned down.
Worries really piqued in the wake of Friday's awful new home sales report. Here's UBS's Sam Coffin with the recap:
The new home sales report for July was very weak, not only because of a 13.4% decline to 394k annual rate in July (cons 487k, UBSe 500k) but also because of downward revisions to the prior three months. June was revised to 455k from 497k; May was cut to 439k from 459k; and April was trimmed to 446k from 453k.
That softness is at odds with increased builder confidence and with households’ positive assessments of homebuying conditions It also seems out of line with mortgage purchase applications, whose recent softening appears to reflect seasonality. (See charts.) Home price measures certainly do not show soft demand. That said, this was an undeniably weak report and raises the possibility that higher mortgage rates are having a larger effect on sales than we anticipated.
What makes the new home sales report even more interesting is that it's arguably the most up-to-date indicator of housing. Here's Guggenheim Partner's Scott Minerd:
...New home sales are booked when a contract is signed, a key difference from existing home sales, which are booked months later when the deal closes. As such, new home sales are the most current indicator of housing activity. This makes the recent collapse of new home sales exceptionally disturbing. All told, there has been a 20.7 percent decline in new home sales in June and July. We would view any other business that experienced a 20 percent decline in activity over a two month period as in a highly difficult position.
BlackRock's Russ Koesterich points to another up-to-date high frequency housing market indicator: mortgage applications.
As interest rates have climbed, mortgage rates have followed suit. The cost of a 30-year conventional mortgage is now at about 4.7%, up from 3.6% in early May, and the monthly mortgage payment on a median US house has increased roughly $200 during the same period. As rates (and mortgage costs) have risen, mortgage and home sales activity has started to falter. A recent Mortgage Banker Association survey shows loan activity down by more than 50% from a May peak...
For the most part, economists also say that this is just one month's worth of data. But they also argue that the data is worth watching closely.
So what are the implications?
Well, investors will certainly be concerned about what this means for 1) monetary policy and 2) the economy.
1) On Monetary Policy
Interest rates began trending higher in May after the Federal Reserve said that it could soon begin tapering its monthly purchases of $85 billion worth of bonds. These purchases — which are formally referred to as Large-Scale Asset Purchases or informally referred to as quantitative easing — consist of $40 billion worth of mortgage-backed securities (MBS) and $45 billion worth of Treasury securities.
These purchases were intended to suppress interest rates, so there are concerns that the tapering, or reduction, of these purchases could lead to higher rates.
Most economists expect some form of tapering to begin in September. But it's unclear what that tapering will look like.
That brings us to the paper presented by Northwestern's Arvind Krishnamurthy and Annette Vissing-Jorgensen at the Kansas City Fed's Economic Policy Symposium this past weekend in Jackson Hole.
Here's the recap from Goldman Sachs' Sven Jari Stehn and Marty Young:
While the Jackson Hole conference was less eventful than in previous years―in light of the lack of a keynote address from a member of the FOMC leadership―a number of interesting academic studies were presented. In particular, a paper by Arvind Krishnamurthy and Annette Vissing-Jorgensen (or "KVJ" for short)―presented by Krishnamurthy at the conference―argues that QE has more narrow effects on asset prices than Fed officials have typically proposed. First, KVJ present evidence that MBS purchases have been more effective than Treasury purchases in lowering mortgage rates and, thus, supporting the economy. The reason is that they find only limited evidence for a broad "duration removal effect," through which taking out duration risk from the Treasury market boosts other, riskier, asset prices. Instead, they argue that Treasury purchases work mainly through a scarcity effect that pushes down Treasury yields but leave riskier asset prices largely unchanged. Purchases of MBS―which lower private borrowing costs more directly―are therefore a more direct and more effective way to boost the economy. Second, KVJ argue that within mortgages, purchases of newly issued (current coupon) MBS have been more effective in lowering mortgage rates than higher coupon MBS purchases. The basic intuition for this is that purchases of current coupon MBS are more effective in encouraging new MBS issuance. KVJ's main vehicle for establishing these results is an event study that looks at the response of different asset prices to the Fed's announcement of its unconventional policy steps.
In short, the purchases of mortgage-backed securities have been more effective than the purchases of Treasury securities.
With this in mind, it is quite possible for the Fed to taper by 1) tapering its Treasury purchases while maintaining its $40 billion worth of MBS purchases or 2) tapering its Treasury purchases while increasing its MBS purchases.
In other words, the Fed may be able to taper while keeping mortgage rates low.
2) On The Economy
Over and over again, we've heard experts cite the housing recovery for growth in everything from consumer spending to corporate profits to GDP.
But a peaking housing market doesn't spell doom for the economy.
Gluskin Sheff's David Rosenberg wrote a note addressing this concern. Here's an excerpt:
...For the here and now and immediate future, no, I am not worried about the housing revival peaking out. There is no evidence that when this happens, the economy suddenly rolls over and plays dead. Quite the opposite. A peaking in the housing market right now would be perfectly normal — normal defined as the historical norm...
...Housing always peaks early in the business cycle. The lag between the peak in housing and the peak in the economic cycle is typically 40 months, not three months. And if the peak was one million in housing starts last March, it will be the first time that has ever happened (and I do understand that the world is different post-crisis as it relates to credit availability and demographics). The two lowest peaks ever in U.S. housing starts were 1.8 million units in the mid-1960s and the late 1990s. So it is unclear that one million was the peak this time around, and higher mortgage rates have to be viewed in the context of improving job market conditions. And even if one million was the peak, the time lag between the peak in the residential sector and the next recession is just far too long for me to fret about right now. Inflation, the yield curve, the unemployment rate and housing all scream early-cycle to me, though the stock market, the boom/bust ratio, productivity and capacity utilization rates in industry suggest mid to late cycle. So I do acknowledge that it is not 100% clear as to where we are in the business cycle right now — but the yield curve tends to win out and is so steep that it would be bizarre to be talking about the expansion being long in the tooth at the current time (though the equity market looks fully priced to say the least).
Rosenberg has been one of the more bearish economists on the Street since the financial crisis. But he has always been one of the sharpest. So we can't help but be encouraged by this.
Ultimately, yes there are reasons to be concerned about the housing market. And if it is indeed turning, the Fed has the capacity to stimulate it. And even if the housing market does deteriorate, it does not mean the economy is doomed.
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