Even with Low Rates, Housing Remains Interest-Rate Sensitive
Fed Chair Janet Yellen and other Federal Reserve Bank presidents and board members have made it fairly clear that interest rates are likely to rise in 2015. The timing and magnitude of any increase in interest rates is still an open question. We expect the Fed to begin to nudge the federal funds rate higher in late summer or early fall. Mortgage rates will likely rise ahead of any change in policy rates, but again the timing and magnitude of any increase remains an open question. Mortgage rates typically track the yield on the 10-year Treasury note and that rate is greatly influenced by the expectations for short-term interest rates over the next few years. How well the Fed manages its message about the future course of short-term interest rates will be a key determinant of how quickly mortgage rates rise.Questions about mortgage rates are timely because we are moving into the peak home-buying season, which is essentially the second quarter. Two years ago, the spring home-buying season was abruptly upended when the Fed revealed that it would likely begin to taper its security purchases sooner than the financial markets expected. Mortgage rates spiked 115 basis points in the span of just 10 weeks and home sales soon crumbled, as many sales contracts were canceled and potential buyers stepped back. Sales of new homes fell 25 percent almost immediately following the “Taper Tantrum” and existing home sales fell roughly 10 percent over the next several months. This is an outcome that policymakers are consciously working to avoid in 2015.
The fact that home sales remain sensitive to rising interest rates is not surprising, but the speed at which this correction took place in 2013 and the magnitude of the pullback in home sales was enlightening. Some had hoped that the housing market would better withstand rising mortgage rates because the increases would come off astonishingly low levels and mortgage rates would still be well below their historic norms even if they rose a percentage point or more. Moreover, low mortgage rates did not appear to be providing much additional support to home sales, so some even argued that the sector had become less interest rate sensitive. That argument does not seem to hold.
We see a couple of reasons why housing may prove to be even more interest rate sensitive than it has been in the past. For starters, median household incomes have barely budged, so housing affordability has fallen as housing prices have rebounded. Qualifying for a mortgage is also more difficult today and income requirements are more stringent. Even a modest rise in mortgage rates could price many potential buyers out of the market, particularly with many younger, first-time buyers carrying a great deal of student loan debt.
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