As regular readers know, your humble blogger, along with a lot of investors, was taken by surprise when the typically dovish Bernanke not only started using the taper word a month ago, but then made the demise of Fed heroics sound even more imminent by talking about higher unemployment “thresholds,” namely 7%, than had been voiced previously. And the reading of Fedwatchers like Tim Duy and (even before the FOMC statement) James Aitken is that the central bank wants out of the QE business sooner rather than later.
Trying to persuade investors that the Fed did not want to be in the QE forever game may not have been a bad move per se, but the monetary authority didn’t soften its taper talk of a month ago. Even the remarks of Richard Fisher of the Dallas Fed (which did lead to an easing of the market decline of Monday) and Narayana Kocherlakota of thhe Minneapolis Fed, weren’t necessarily as soothing as upbeat headlines might lead you to believe (see Bloomberg versus MacroBusiness). Nevertheless, the fact that two Fed presidents noticed that Mr. Market was having a conniption fit and decided to have a chat with him might have been reassurance enough.
The underpinnings of this spotty and tepid recovery have been improving consumer confidence due to recovery in home prices and a rising stock market (I continue to find it remarkable that many people treat stock market levels as a proxy for the health of the economy). Employment and wage improvements are tepid, but consumer borrowing (student loans, auto loans, housing) have helped drive spending.
With home price appreciation being touted as a sign that all is better, the peculiar dismissal by Bernanke of the recent sharp rise in mortgage rates is another sign of how disconnected the Fed is. I have two friends who are looking for homes and both were freaked out by the rate rise even prior to the latest ratchet up since the FOMC meeting. The increase might well produced a last hurrah as buyers rush to get deals done out of fear that interest rates are running away from them. But several posts tonight give concrete evidence of how much damage has likely already been done to the housing “recovery,” although it will take several months to translate into price and activity data.
First is from Housing Wire, in which Fannie Mae’s chief economist takes issue with the notion that 4% mortgage rates is nothing to be concerned about:
Fannie Mae Chief Economist Doug Duncan said the concern should be less about what the rates have risen to and more about the speed at which they are rising.
Duncan noted that in 1994, for instance, rates rose 2% over a 12-month period, resulting in a huge impact on home prices, which fell significantly.
“If the rise happens rapidly, it tends to have an impact,” said Duncan, who added that once rates rise 100 basis points, home sales may begin to slow.
Um, looking at Bloomberg, the 30 year fixed is at 3.51%, up 76 basis points in a mere month, and a smidge over 100 since March. So we are already in the danger zone.
Michael Shedlock has a report from the trenches that the actual increases are worse than the increase in rack rates like those reported by various data services ise would lead you to believe. From his buddy Michael Becker:
As bad as Treasuries are selling off, the sell off in MBS is much worse. I looked at some charts this morning and the prices of Fannie Mae and Ginnie Mae coupons continue to drop.
The FNMA 3.5 coupon was trading at 106 22/32 on May 2nd, and this morning it was trading at 99 9/32. Ginnie Mae is worse. The GNMA 3.5 coupon was trading at 109 1/32 on May 2nd, and this morning it was trading at 99 24/32.
In terms of interest rates, I locked an FHA purchase on May 2nd and the rate was 3.25%, and that rate carried a 2 point lender credit to help pay for closing costs. In order to get the same deal today, (a 2 point lender credit) the rate would have to be 5% today.
This as an apples to apples comparison illustrates that FHA rates have increased 1.75% in 7 weeks. You could get 4.625% on an FHA purchase, but you wouldn’t get any closing cost help.
I was locking well qualified borrowers at 3.50% on conventional loans (Fannie Mae) at the beginning of May, and now they are looking at 4.875%.
Most of this pain has occurred since the FOMC meeting last Wednesday, and I am sure the talking heads at CNBC have no idea how much interest rates have spiked. They keep saying that housing is strong enough to withstand this rise in rates, but I think they are deluding themselves.
I have people who I pre-approved for a mortgage early last week prior to the FOMC meeting, and now that they are getting their contracts accepted and ratified are shocked to learn mortgage rates have spiked one percentage point in just the last few days.
So we are actually well beyond the rate rise increase level that Doug Duncan saw as dangerous to the health of the housing market. He warned about 200 basis points in a full year as being a destructively fast rise. Becker is seeing 175 basis points in less than two months. Shedlock drives the point home (pun intended):
A one percentage point rise in rates affects affordability by 10-11%. With mortgage rates up 1 3/8 to 1 3/4 points, that equates to a rise in monthly payments (or a drop in affordability) by as much as 17%. Anyone who stretched to buy is no longer qualified unless they locked some time ago.
Clusterstock cites a different set of concerns from Paul Diggle of Capital Economics:
1. The double digit price gains we’ve seen recently are not sustainable. “If prices continue rising at 12.1% y/y – the latest CoreLogic reading – housing will be overvalued relative to rents within the next few months and relative to incomes in early-2015. And combined with the assumption that mortgage interest rates settle at their current 4.2% level, mortgage servicing costs will rise by 2%-3% of income each year.”
2. The home price gains have already made it harder for investors to find “bargains.” It will take some time before traditional homeowner demand makes up for the decline in investor demand and this should slow the pace of home price gains.
3. Inventory seems to have bottomed and “sellers are starting to return in greater force.”
Diggle does not mention that the investors will also be freaked out about the sudden decline in affordability, since some will have a sale to a real end buyer as their exit (as in at these levels, rental yields alone won’t meet their return targets, they also need capital appreciation, and that means selling it eventually to a non-investor). A further issue re investors is despite the fact that they are typically described as “all cash,” that simply means they aren’t financing with a mortgage. The fact that Berkshire Hathaway has stepped in and is offering warehouse lines (18 to 24 months) to buyers in a portfolio size range they saw as underserved (this is from memory, but I believe it was $5 to $25 million) strongly indicates that the bigger fish were using credit too.
Now that does not mean we won’t see solid housing numbers for the next couple of months. We won’t see much impact from the Fed’s moves in the releases out today, since they cover April and next month (as indicated above) might still be buoyant due to buyers either locking in favorable rates or rushing to buy before rates rise further. But it’s hard to see how you can be that optimistic about housing going forward after the Fed managed to botch its strategy, its communications, or both, and inflict a rate shock.