Summary: Yesterday, I posted a piece arguing the Fed rate hike was a mistake and inflation and rates are headed down from here. Rate hikes don’t work by gradually curbing spending; they work by freezing asset markets dead in their tracks. The best example today is the residential property market where 7% mortgage rates have made buying a home unaffordable for most people at anything near recent home prices. It will take substantial cuts in rates to thaw the market.
I share your concern about the credit market tightening. I recall you making the point long ago at a Telecosm Conference that while interest rates are important, the availability / access to capital is far more important. That said, I don't know where to look for data to quantify what is broadly termed as "tightening." If you could give me some direction here it would be appreciated.
I'm confused by what the data show in the existing home sales market. If we assume that the average mortgage rate for 81% of homeowners with an existing loan is 3.5% and the current rate is 7.25%, the principal and interest would be a little over 50% higher for a 30-year loan at 7.25%. For a 15-year loan it would be a little less than 28% higher. The other 19% of homeowners with existing loans have mortgage rates greater than 5% today.
Since home buyers who take out a mortgage are typically "payment" buyers (qualify based on payment versus home price), that would lead me to believe prices for existing homes would be lower when interest rates are higher. This was initially reflected in the Case Shiller existing home price index when it fell from an all-time high of 308 in January 2022 to 293 (about a 5% decline) in January 2023. However, it recovered to 305 in May 2023.
Existing home sales fell to an annualized rate of 4.3 million units as of May 2023 data. That is nearly 15% down from 2022, but very similar to what we saw from 2008 through 2011. The Case Shiller existing home price index fell over 20% from its peak in 2006 when the average 30-year mortgage rate was about 6.75% to the trough at the end of 2011 when the average 30-year mortgage rate was slightly less than 4%. It took a little more than 10-years for the Case Shiller index to reclaim its 2006 high and at that time, the average 30-year mortgage rate to 3.5% - almost half what it was in 2006. With other knowledge, we know that much of these anomalies were driven by housing prices increasing too much in the 2006 bubble. The same could be said about the NASDAQ, which took roughly 15-years to reclaim the high it set in 2000. Bubbles happen...
What the data seem to show is home prices have not declined as I would have expected with more than a doubling of interest rates. The logical conclusion is inventory is low and that is holding prices up. We can see existing homes available for sale (inventory) is about 50% below normal levels, but that it is similar to what it was at the close of 2020 and up over 25% from the trough in early 2020 when interest rates were very low. These data are consistent with the theory that people are reluctant to sell their current home with a low interest rate and buy a new one at a much higher interest rate at a similar relative valuation (Case Shiller index value).
Fixed income yields tell us markets expect interest rates to decline in six to 24 months. Maybe the housing market reads this and is in somewhat of a wait and see mode. However, I think there is also a good chance we will see a large jump in existing housing sales at some point in the near future (assuming there is no significant economic decline - recession) as pent-up demand kicks in.
John--I appreciate the value of liquid markets, and recognize that in some cases the price/availability of housing options is discouraging mobility and household formation. But to a great degree, I think the angst over a limited "resale" market is overdone. This is primarily a problem for real-estate agents and other businesses in the transaction pipeline. As a nation we promote the buying and selling of homes (tax breaks) when in many cases retained ownership has arguable benefits both for families and neighborhoods. "Flipping" is a very mixed outgrowth of housing liquidity. You want assets that are oversized for empty-nesters to be redeployed, and the higher (normal?) interest rates deter some of that, but I'm not convinced that was much of what was occurring in the churn of the last few decades. Please set me straight on this apostasy.
Dr John,
I share your concern about the credit market tightening. I recall you making the point long ago at a Telecosm Conference that while interest rates are important, the availability / access to capital is far more important. That said, I don't know where to look for data to quantify what is broadly termed as "tightening." If you could give me some direction here it would be appreciated.
I'm confused by what the data show in the existing home sales market. If we assume that the average mortgage rate for 81% of homeowners with an existing loan is 3.5% and the current rate is 7.25%, the principal and interest would be a little over 50% higher for a 30-year loan at 7.25%. For a 15-year loan it would be a little less than 28% higher. The other 19% of homeowners with existing loans have mortgage rates greater than 5% today.
Since home buyers who take out a mortgage are typically "payment" buyers (qualify based on payment versus home price), that would lead me to believe prices for existing homes would be lower when interest rates are higher. This was initially reflected in the Case Shiller existing home price index when it fell from an all-time high of 308 in January 2022 to 293 (about a 5% decline) in January 2023. However, it recovered to 305 in May 2023.
Existing home sales fell to an annualized rate of 4.3 million units as of May 2023 data. That is nearly 15% down from 2022, but very similar to what we saw from 2008 through 2011. The Case Shiller existing home price index fell over 20% from its peak in 2006 when the average 30-year mortgage rate was about 6.75% to the trough at the end of 2011 when the average 30-year mortgage rate was slightly less than 4%. It took a little more than 10-years for the Case Shiller index to reclaim its 2006 high and at that time, the average 30-year mortgage rate to 3.5% - almost half what it was in 2006. With other knowledge, we know that much of these anomalies were driven by housing prices increasing too much in the 2006 bubble. The same could be said about the NASDAQ, which took roughly 15-years to reclaim the high it set in 2000. Bubbles happen...
What the data seem to show is home prices have not declined as I would have expected with more than a doubling of interest rates. The logical conclusion is inventory is low and that is holding prices up. We can see existing homes available for sale (inventory) is about 50% below normal levels, but that it is similar to what it was at the close of 2020 and up over 25% from the trough in early 2020 when interest rates were very low. These data are consistent with the theory that people are reluctant to sell their current home with a low interest rate and buy a new one at a much higher interest rate at a similar relative valuation (Case Shiller index value).
Fixed income yields tell us markets expect interest rates to decline in six to 24 months. Maybe the housing market reads this and is in somewhat of a wait and see mode. However, I think there is also a good chance we will see a large jump in existing housing sales at some point in the near future (assuming there is no significant economic decline - recession) as pent-up demand kicks in.
Best Regards,
Paul
John--I appreciate the value of liquid markets, and recognize that in some cases the price/availability of housing options is discouraging mobility and household formation. But to a great degree, I think the angst over a limited "resale" market is overdone. This is primarily a problem for real-estate agents and other businesses in the transaction pipeline. As a nation we promote the buying and selling of homes (tax breaks) when in many cases retained ownership has arguable benefits both for families and neighborhoods. "Flipping" is a very mixed outgrowth of housing liquidity. You want assets that are oversized for empty-nesters to be redeployed, and the higher (normal?) interest rates deter some of that, but I'm not convinced that was much of what was occurring in the churn of the last few decades. Please set me straight on this apostasy.