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Most market pundits expected this to happen four years ago, if not earlier.

May 21, 2018

Most market pundits expected this to happen four years ago, if not earlier.

They expected interest rates to rise, and rise meaningfully with sustained momentum.

Interest rates failed to follow the script. They’ve made up for their ad lib in 2018. Interest rates have trended in one direction – up. They continue to trend up as we write.

In the past week, the 10-year U.S. Treasury note yield has risen 12 basis points. The latest increase means the yield has risen 60 basis points year to date.

As the yield on the 10-year note goes, so go the rate quotes on long-term mortgages. The standard-bearer – the prime 30-year conventional mortgage – has kept pace with the 10-year note. Rates have risen 60 basis points since the beginning of the year. Rates are at a seven-year high. The range based on the national average has risen to 4.75%-to-4.875%.

It appears unlikely that mortgage rates have finished their ascent.

Oil prices have risen relentlessly since the beginning of the year. A barrel of West Texas Intermediate Crude goes for $71 on the spot market. It’s at a three-high. A barrel of WTIC cost less than $30 a barrel only two years ago.

Not surprisingly, transportation costs are on the rise. A recent Wall Street Journal dispatch noted that senior executives at many major U.S. companies report higher transportation costs. The WSJ cited Coca-Cola, Procter & Gamble, Nestle, and Hasboro. These companies are reporting transportation-cost increases in percentages measured in the high-single digits to high-teens.

These companies will push as much of their increased costs as they can onto consumers with higher prices. So, inflation is what we’re really talking about. Consumer-price inflation is a key variable in setting interest rates, particularly on the long-end of the curve. Consumer-price inflation is on the rise.

The April Consumer Price index posted a 2.5% year-over-year increase – its hottest reading since February 2017. The New York Federal Reserve’s Underlying Inflation Gauge (which aims to capture “sustained moves in inflation from information contained in a broad set of price, real activity, and financial data”) was more telling. It rose 3.2% year-over-year in April. That’s the highest reading since July 2006.

The Federal Reserve has wanted more consumer-price inflation for the past seven years. It’s finally getting what it wants. Consumer-price inflation has accelerated this year. That said, Federal Reserve officials are sanguine on the matter.

Federal Reserve Bank of Dallas president Robert Kaplan Kaplan forecast in a recent speech: “In the medium term, I think inflationary forces are still going to be more muted . . . Most of the forces in the world are deflationary.”

For anyone who fills up the gas tank and shops at the grocery store, the deflationary forces are difficult to decipher. Just by eyeballing the joint, we see consumer prices rising.

We mentioned last week that JPMorgan Chase CEO Jamie Dimon forecasts a 4% yield on the 10-year U.S. Treasury note. That yield still has some distance to cover before it hits 4%, but it’s progressing in that direction.

Therefore, don’t be surprised to see rate quotes on the prime 30-year conventional mortgage hit 5% in the near future. Then don’t be surprised to see rate quotes progress higher from there.

Holding Steady for Now

The Home Builder Sentiment Index held at 70 in May. It has held near 70 for 2018. Home builders remain optimistic, though they’re less optimistic compared to a year ago.

Business, fortunately, is still good. Housing starts in April were at a seasonally adjusted annual rate of 1.287 million. This is 3.7% below the revised March estimate of 1.336 million, but it is 10.5% above the start rate compared to a year ago.

As for mortgage activity, business has slowed in recent weeks. No surprise that refinances trend down, but so, too, have purchases. Purchase applications were down 2% in the latest reported week. Activity is still up 4% compared to last year.

We know that some market watchers are concerned that rising interest rates spell the end of the good days for housing. We’re not one of them. Let’s keep in mind that the economy is strong, businesses are reporting record profits, employment is at a multi-year high. These are sufficient positives to suggest that more good days are forthcoming.

Rising Interest Rates Still Low by Historical Standards

May 16, 2018

Rising Interest Rates Still Low by Historical Standards

It’s already been clear that 2017 was a banner year for residential real estate sales. But when it comes to projections for 2018 and a spring home sales season that’s already underway, certain factors could cause the year to turn out quite differently.

The primary concern for 2018 is not necessarily home prices, although they continue to increase throughout much of the U.S. Instead, mortgage interest rates may well determine the outcome of the year for buyers, sellers and investors.

The Causes and Effects of Rising Rates

Interest rates remain relatively low compared to historical averages, but have increased rapidly since the beginning of 2018. As of April 19, the latest report on mortgage rates from Freddie Mac found that average interest rates had jumped to their highest point in four years. The average rate on a 30-year fixed-rate home loan was pegged at 4.47 percent. This news came on the heels of the latest release from the Federal Reserve’s Beige Book, a collection of economic analysis that markets often look to for insights on future policy direction. Since the Fed continues to see overall economic growth and employment rates as favorable, it’s widely expected that the central bank of the U.S. will keep raising prime interest rates incrementally throughout 2018, and that is now being priced into mortgage rates.

What does this all mean for the average consumer who either owns a home or is looking to make a purchase soon? For the majority of Americans who rely on mortgages to buy property, higher interest rates of course make that prospect more expensive. However, according to classical economic theory, asset prices tend to move in the opposite direction of interest rates. This may explain why researchers, including those at Zillow, anticipate home prices to grow slower in 2018 than the previous year.

Takeaway For Owners and Sellers

This is not to say that homeowners need to worry about the value of their investment. Nor is it a prediction that real estate sales will choke from rising rates. A report from Freddie Mac expects home price growth to continue outpacing inflation in the coming years. Strong employment and high levels of consumer confidence will keep buyers coming, although those without significant savings may not find a reasonable entry point into the housing market anytime soon. Interest rates are expected to continue rising incrementally through 2018, with the average interest rate on a 30-year fixed-rate mortgage predicted to approach 5 percent by the end of the year.

“While housing market trends have been generally favorable, not everyone has shared equally in the gains,” according to Freddie Mac’s most recent report on the U.S. housing market. They point out that besides buyers who have been priced out of certain markets, current homeowners living on fixed incomes may not necessarily welcome higher property values, either. That’s because property taxes also tend to increase along with a home’s value, creating an additional burden for owners. On the other hand, this could prompt more of them to enter the market as sellers.

The housing market in 2018 is looking complicated, but not bad overall. For many homebuyers and sellers, the same basic fundamentals still apply.

Is Four in Store?

May 14, 2018

Is Four in Store?

The yield on the 10-year U.S. Treasury note hovers just above 3% as we write. It hasn’t hovered this high since December 2013. Rate quotes on a prime 30-year fixed-rate conventional mortgage hover between 4.625% and 4.75%. They haven’t hovered this high in four years.

Jamie Dimon, chairman and CEO of JPMorgan Chase, believes that we’re not done yet. He sees a 4% yield on the 10-year note. Dimon didn’t say when the 4% yield will materialize. We assume (usually not a good thing to do) he means within the next year to 18 months.

Interestingly enough, the 3% yield on the 10-year note that prevailed in 2013 didn’t ratchet up to 4%. It ratcheted down to 2%. In late January 2015, the yield even briefly dropped to 1.7%. A well-timed call to a mortgage lender could have elicited a 3.625% rate quote on a prime 30-year fixed-rate mortgage.

No two epochs are alike, of course. Consumer-price inflation was dormant back then. It would remain dormant over the subsequent four years. The Federal Reserve also had the range on the federal funds rate set at 0%-to-0.25%. The effective rate was only 10 basis points.

Today, consumer-price inflation has emerged. It runs slightly above the Fed’s 2% annualized goal. The range on the fed funds rate has risen, through a series of 25-basis-point increases, to 1.5%-to-1.75%. The effective rate is 1.7%. The range will likely be increased another 25 basis points next month. It will likely be increased another 25 basis points after that.

Given the market dynamics today, Dimon is likely more right than wrong. A 3% yield giving way to a sub-2% yield on the 10-year U.S. Treasury note is highly unlikely. That being the case, a return to sub-4% rate quotes on a 30-year conventional mortgage is equally unlikely.

The good news is a growing economy can handle it. Like Dimon, we believe the economy, including housing, can absorb rising interest rates. A 4% yield on the 10-year note is nothing to worry about, with one caveat. The yield curve must remain normal. It’s normal when each successive yield on U.S. Treasury securities is higher than the previous yield.

If we see yields on short-term Treasury securities rise above yields on long-term Treasury securities, we might worry. At the least, we’ll contemplate the possibilities. When the yield curve inverts, short-term yields rise above long-term yields, a recession usually appears within the next 24 months.

The yield on the 10-year note is 44 basis points higher than the yield on the two-year note. The spread was 54 basis points at the start of the year. It was 100 basis points a year ago. We’re not worried, but we would like to see a little more distance separate the two securities.

Hooray for Falling Prices!
Recent data from Trulia show that home prices really don’t rise all the time.

Indeed, the data show that the median price of a home listing in six of the 100 largest markets remains unchanged or has dropped year over year. The median list price is up less than a percentage point in four other markets.

San Antonio reported the largest decline in the median list price, with a 5.4% decline. Denver, one of the hottest markets post-bubble burst, has seen only a 0.9% increase in the median list price.

The median number is a dividing number: half the listings are above and half are below the median price. It doesn’t mean every listed home in San Antonio has dropped 5.4% or that every listed home in Denver has risen 0.9%.

Trulia correctly notes that the drop in the median list price can be the result of a healthy event, such as more home builders building lower-priced homes. The normalization of a market would be another healthy event. For instance, the median list price for a home in Honolulu is down 1.4% year over year, but it is up 18% over the past two years.

Many market watchers reflexively believe that higher is better: Rising prices are a sign of a healthy market. That’s not always the case, particularly when prices relentlessly rise above historical norms. When that occurs, demand is eventually exhausted. A market correct, frequently unpleasant, will follow exhausted demand.

More of the Same for Mortgage Rates

May 7, 2018

More of the Same for Mortgage Rates

The latest meeting of Federal Reserve officials came and went on Wednesday. The meeting came and went as anticipated. Fed officials held the range on the federal funds rate – an influential overnight lending rate – at 1.5%-to-1.75%.

Credit-market participants reacted with the expected yawn. Yields on U.S. Treasury securities (and other quality debt instruments) barely budged.

No one should be surprised the market response was universal indifference. That which is anticipated rarely elicits action. Everyone anticipated the Fed to maintain the range on the fed funds rate. The Fed followed the script.

Everyone also anticipates the Fed to lift the range on the fed funds rate when officials convene again in June. Everyone expects the range to rise to 1.75%-to-2%. So when the Fed lifts the range next month, expect the market response to be similarly muted.

Words can speak louder than actions, though. The event itself, the holding or raising of the fed funds rate, will elicit indifference. The press conference following the event can move markets. A Fed official, being human, can say something that was off script and unanticipated.

No such luck this time. Fed officials held to form. Here again, everything was anticipated.

Fed chairman Jerome Powell was broadly optimistic about the U.S. economy, but he noted a few risks. (There are always a few risks.) The trade dispute China was highest among the risks. Powell mentioned that consumer-price inflation was finally running at the Fed’s designated 2% annualized rate. Wage-price inflation was a concern given low employment. Employers might need to funnel more dollars into wages to entice scarce employees. More wage-price inflation can lead to more consumer-price inflation.

As for us, it was business as usual. Quotes on mortgage rates were equally muted compared to yields on most debt instruments. Quotes on prime 30-year fixed-rate conventional mortgages continue to hold the 4.625%-to-4.75% range established last month.

Given that U.S. GDP growth was underwhelming in the first quarter, mortgage quotes should hold the range for at least the near future.

A pre-summer lull appears to have descended upon us. With what we know and with what credit-market participants anticipate, mortgage-rate volatility should remain dormant. Borrowers might be able to pick up a few basis points on a short-term float. But is the reward worth the risk? We can’t say. It’s a coin flip.

We mentioned last week why it’s worthwhile to monitor the yield curve, which has flattened over the past month. The spread between the two-year note and the 10-year note has narrowed to 50 basis points. The spread between the 10-year note and 30-year bond has narrowed to 20 basis points.

A flattening yield curve is no big deal; an inverting yield curve is. If short-term yields rise above long-term yields, take note. Inverted yield curves have preceded nine of the past 10 recessions.

Still Stuck in Purgatory

The NAR’s Pending Home Sales Index showed only marginal improvement in March. The latest reading suggests that we shouldn’t see much change in existing-home sales over the next month or two. No surprise here: low inventory driving relentless price appreciation continues to constrain sales growth in many markets.

Home inventory is unlikely to receive a boost from new construction. Bureau of Economic Analysis data show single-family-home investment running at $280 billion on an annualized rate. The number sounds big in isolation. Relatively speaking, it’s not so big. It’s roughly 1.4% of GDP, at the low end of historical percentages.

Single-family-investment is low. It’s low enough to be below the bottom of previous recessions as a percent of GDP. Home builders have had troubled getting into gear. They have been plagued with accelerating land, labor, material, and regulatory costs. That’s unlikely to change any time soon.

Many market watchers are concerned rising interest rates, including rising mortgage rates, will eventually trip up housing. We’re not one of them. The consumer market is healthy enough to absorb higher mortgage rates. The issue is more fundamental: More inventory for sale and more housing supply, in general, are needed. Until that occurs, little will change on the sales front for the foreseeable future.

Low Inventory Continues to Influence Housing Market

May 3, 2018

Low Inventory Continues to Influence Housing Market

As more data and insight into the housing market comes out, it’s clear that 2017 was an earth-shattering year for residential real estate. According to a report from Zillow based on home sales data from the prior year, there has not been a year on record in which homes sold faster. Based on Zillow’s data from its proprietary listing service, the average home was on the market for just 81 days, including closing. During June 2017, the hottest month of the year for home sales, median listing times were as low as 73 days nationally. In certain markets, that number went even lower: Los Angeles clocked a median sales time of 59 days in May, while San Francisco homes tended to sell in just 41 days around the same time.

Housing inventory is not only selling faster – it has tended to fetch higher prices, too. Another Zillow report found that around 25 percent of homes sold for more than their list price in 2017. For comparison, only 18 percent of home sales in 2012 went for more than the initial asking price. On average, Zillow found that listings that sold for above their sticker prices garnered an additional 3 percent – a sizeable takeaway for sellers and a hefty additional expense for buyers.

More Americans continue to enter the housing market, but inventory remains a concern. According to Lawrence Yun, Chief Economist of the National Association of Realtors, the market continues to favor sellers as low inventory pushes prices higher, and reduces the time required to sell.

“Affordability continues to be a pressing issue because new and existing housing supply is still severely subpar,” Yun said in the latest report on existing home sales data. Research from the NAR indicates that in March, the U.S. market for existing homes had only 3.4 months worth of inventory available. That would be almost half of the six months of stock that economists generally consider equally beneficial for buyers and sellers.

Inventory Squeezes First-Time Buyers
The NAR’s report also warns that such market conditions may be wearing down first-time homebuyers in particular. This share of buyers comprised 34 percent of the homebuying market in 2017, but that proportion has slipped in the first months of the New Year.

“[Real estate agents] in several markets note that entry-level homes for first-timers are hard to come by, which is contributing to their underperforming share of overall sales to start the year,” according to NAR President Elizabeth Mendenhall. “Even with the expected uptick in new listings in coming months, buyers in most markets will likely have to act fast on any available listing that checks all their boxes.”

Home sales continue to post strong results in many local markets, proving that buyers in many places are not being totally priced out of homeownership. As prices are expected to moderate through 2018, it stands to reason that affordability will improve slightly and first-time buyers will see an opportunity to make a move.

The Long-term has arrived sooner than expected.

April 30, 2018

The Long-term has arrived sooner than expected.

The Long-term has arrived sooner than expected.

We have said repeatedly this year that the trend in mortgage rates will be higher over the long term. We offered this opinion last week: “Odds are that mortgage rates will rise longer term. Predicting with accuracy when the short term will give way to the ‘longer term’ is never a sure bet.”

Indeed, it’s never a sure bet. It turns out the short-term was shorter than we expected.

Mortgage rates have moved meaningfully higher over the past few days. They’ve moved high enough to establish a new range. The old range of a 4.5%-to-4.625% rate on a prime 30-year fixed-rate mortgage (at the national level) has given way to a 4.625%-to-4.75% range. No one should be surprised above the move north, though.

The yield on the 10-year U.S. Treasury note made for the heavens over the past week. The yield jumped nearly 20 basis points over just a few trading days. The yield hovers around 3% as we write. The 10-year note hasn’t offered so high a yield since the waning days of December 2013.

It’s all circular, really: Yields on mortgage-backed securities (MBS) take their cue from the yield on the 10-year Treasury note. Long-term mortgage rates take their cue from yields on MBS. Mortgage rates had no choice but to establish a higher range.

A combination of factors has served as fuel for the interest-rate rise.

Another Federal Reserve interest-rate hike is one. More market participants are gaming for four increases before the year is over. Most were gaming for three at the start of the year. The next increase will likely occur in June.

Consumer-price inflation shows increasing signs of moving to a higher range. According to the Federal Reserve’s Underlying Inflation Gauge (UIG), the 12-month inflation growth was 3.13% in March. That’s the highest rate recorded in nearly 12 years. The last time the UIG was this high was in July 2006, when it was at 3.2%

Wage inflation, which has remained mostly subdued since the last recession, also has market participants on edge. The unemployment rate at 4.1% is low; demand for labor (qualified labor, to be specific) is high. Something has to give on either the wage or demand fronts. Most market watchers expect it to give on the wage front.

Companies continue to make money at an elevated rate. FactSet reports that 17% of S&P 500 companies have reported first-quarter financial results. Eighty percent of the reporting companies reported a positive earnings surprise (above the consensus estimate). S&P 500 earnings are expected to grow 18.3% year-over-year for the quarter. That’s the highest annual increase since 2011.

It’s all good for the U.S. economy, which means it’s mostly bad for the interest-rate trend. With the information we have today, we see little reason not to expect quotes of 5% or higher on a 30-year conventional mortgage by the end of the year.

Sales Up, But for How Long?

Both existing and new homes posted monthly sales gains for March.

Existing-home sales rose 1.1% to post at 5.6 million on an annualized rate for the month. This was the second-consecutive increase, but it still leaves sales down compared to a year ago. Sales are down 1.2% compared with the year-ago period.

It’s common knowledge why sales-grow lags – lack of inventory. The number of existing homes increased slightly in March, but it’s still down 7.2% compared with a year ago. At the current sales pace, only 3.6-months supply is on the market.

Sales of new homes were surprisingly spry in March. Sales were up 4% to post at 694,000 on an annualized rate. Through the first quarter of 2018, new-home sales are running 10.3% higher than a year ago.

The surge is less impressive, though, when the composition of the trend is considered. The increase was overwhelmingly driven by sales in the red-hot West, which were up 28.3%. Sales were also concentrated at a higher price point. Sixty percent of sales were for homes priced $300,000 or above. Two years ago, these homes accounted for 53% of sales. Affordable entry-market new homes remain a rare commodity.

And prices, they continue to rise.

The latest reading of the S&P CoreLogic Case-Shiller Home Price Index shows home prices rose 6.3% year over year in February. The West again led the index. Seattle, Las Vegas, and San Francisco all posted double-digit year-over-year price gains.

It’s all mostly good. Nevertheless, the trends in home prices, mortgage rates, and inventory could cool sales in the coming months, even in the red-hot West.

Why the Yield Curve is Suddenly the Center of Attention

April 23, 2018

Why the Yield Curve is Suddenly the Center of Attention

Media commentary on the yield curve has spiked in recent weeks.

So, why all the chatter and why does it matter?

The yield curve comprises a plot of U.S. Treasury security yields, with maturities ranging from one month to 30 years (11 plots in total). The yield curve is considered “normal” when the plot of each successive maturity is higher than the previous maturity to produce an upward sloping curve.

The yield curve is normal as we write. The issue is that it has continually flattened this year. The spread between short-term yields and long-term yields has shrunk. Markets pay particular attention to the spread between the yields on the two-year and 10-year Treasury notes.

The spread between the two securities was 90 basis points a year ago. Today, the spread is roughly 40 basis points. (The two-year note yields approximately 2.4%; the 10-year note yields approximately 2.8%.)

The yield curve has flattened precipitously this year. The concern is that the curve could continue to flatten and then invert – short-term yields would rise above long-term yields.

The concern is legitimate because every time the yield curve has inverted since 1956 a recession has followed (usually within a year). The yield curve was last inverted in June 2007. We all know what followed shortly thereafter – the Great Recession and the bursting of the housing bubble ensued.

The yield curve is still far from inverting, but its shape is worthwhile to monitor. After all, recessions are a big deal.

As for the height of the yield curve, Treasury yields have risen across the board since January. This includes the influential 10-year Treasury note, which has risen 35 basis points this year. The 10-year note has taken a breather. The yield has hovered around 2.8% for the past three weeks.

As the yield on the 10-year note goes, so go mortgage-rate quotes. Quotes on the prime 30-year fixed-rate loan continue to hold the 4.5%-to-4.625% range on the national scene. Quotes also continue to hold closer to 4.5%, as they have for most of April.

Recent U.S. hostilities with China and Russia (in Syria) have put financial-market participants on edge. Treasury securities provide a haven for edgy participants. Therefore, mortgage borrowers with a low-time frame and a high-risk threshold might consider floating their loan.

“High-risk threshold” is the operative term. The risk could easily outweigh the potential benefits.

We can’t forget that all commercial interest rates — e.g., the rate quoted on a mortgage — flow from the federal funds rate on a cost-plus basis. The Federal Reserve is keen to raise the fed funds rate at least a couple more times this year (after raising the rate in March).

Odds are that mortgage rates will rise longer term. Predicting with accuracy when the short term will give way to the “longer term” is never a sure bet.

The Shortage: Nationally and Locally
We frequently present national numbers when presenting data. Homes for sale on the national level are in short supply. This is reflected in the monthly data offered by and other sources on home sales and supply. Neither has been able to gain traction.

When the national numbers are distilled to local markets, they frequently change. The national number frequently has no direct bearing to a particular local market.

Then again, the national number might have a direct bearing. We find that the national numbers on home supply mirror the numbers in many local markets. The housing shortage is a big deal in many local markets.

The Wall Street Journal recently drove home the shortage point in a recent article titled “Just How Widespread Is the Housing Shortage?” The article reveals that shortages aren’t merely cloistered in the coastal markets (which would skew the national data). The Journal tells us shortages are widespread.

In a separate survey of 117 American mayors, “housing costs” (a corollary to supply) was the top reason why residents moved away. The survey’s author, Katherine Levine Einstein, says, “Those numbers hold exactly the same when you look at the northeast, the southeast, the southwest and the northwest or when you look at rich cities or poor cities.”

Unfortunately, housing starts this year are unlikely to meaningfully increase supply. We see little reason why we shouldn’t expect home prices to ratchet higher and for supply to remain stubbornly tight.