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Single-Family Home Starts Stall As Fed Mulls QE Shift

Construction on single-family homes is flattening out as central bankers prepare the next clue on when they will start slowing the pace of stimulus.

A recovering housing market is one of the Federal Reserve's goals for its quantitative easing program. While prices are climbing, fears that QE will soon be scaled back have lifted mortgage rates sharply, making homes even costlier.

May housing starts reached an annualized pace of 914,000 units, up 6.8% from April, as volatile apartment construction rebounded, the Commerce Department said Tuesday.

But single-family starts were little changed at 599,000 and have returned to the pace seen in October, following a spike on post-Superstorm Sandy rebuilding. Starts in the Northeast fell for a third straight month.

Permits overall eased 3% last month on multifamily declines. Single-family permits rose 1.3% to an annualized 622,000, the highest in five years, indicating construction will pick up later.

U.S. stock indexes rallied sharply for a second straight day on hopes Fed Chairman Ben Bernanke on Wednesday will calm fears of QE tapering. Shares of homebuilders D.R. Horton (DHI), Lennar (LEN), PulteGroup (PHM) and KB Home (KBH) didn't move much.

April and May housing starts point to a drop in construction activity in Q2 vs. Q1's pace as well as a significant weakening in residential investment, says Yelena Shulyatyeva, an economist at BNP Paribas.

Part of it is due to the pullback after post-Sandy reconstruction. Fiscal tightening and the global economic slowdown are head winds too.

She thinks it's too soon to tell if the slower momentum in housing starts is a new trend. Housing should still be a bright spot overall, and mortgage rates remain historically low, she adds.

Investors may also start buying up new homes after absorbing much of the stock of distressed existing homes, bolstering housing starts.

"Inventories are so lean," said Shulyatyeva. "(Homebuilders) do see potential later.

Builders Bullish

That could be why sentiment among builders reached a seven-year high in June, despite the rapid increase in mortgage rates. The survey from the National Association of Home Builders found assessments of current conditions, expectations and customer traffic improved strongly.

Rising rents will continue to make housing attractive to institutional as well as mom-and-pop investors. Rents drove annual inflation in housing costs to 2.2% last month, the most since January 2009, the Labor Department said Tuesday.

But mortgage rates have risen enough to stifle the housing recovery to some extent, and the latest data suggest builders remain relatively conservative, says Brian Bethune, an economics professor at Gordon College, in a research note.

Expectations that the Fed will tighten eventually are trumping the reality of its asset purchases, which offer additional stimulus even at a reduced monthly pace.

"The Fed tightening genie has escaped from the bottle much earlier than the Fed had planned," Bethune wrote. "This will require yet another Houdini act from Fed Chairman Ben Bernanke."