ABA Banking Journal - September/October 2015 - (Page 22)
> ECONOMIC OUTLOOK
The Economy as a Leading
Indicator for Housing
bY DoUGlAs G. DUNcAN
THINgs HAVE BEEN looking up in housing. Sales are rising, starts are
strengthening, consumer attitudes are improving and prices are rising.
This is in line with our forecast of a better 2015 than 2014. However,
housing market participants are a bit nervous about the pending change
of Federal Reserve policy and its potential impact on mortgage rates
and the performance of their sector of the economy.
That is a reasonable view given the
evidence from the "taper tantrum"
of the second half of 2013, the
change it drove in interest rates (up
over 100 basis points in 6 months)
and the resultant impact on housing
in 2014 (down from 2013). We
don't think the expected change in
the federal funds target, which we
believe will happen in September,
will generate a "tightening tantrum"
spike in 10-year treasury rates, but
it is not out of the question. Despite
some pretty significant signals of a
September rate increase by the Fed,
markets still assign a low probability
of that increase in September, which
suggests some degree of surprise
unless that expectation changes
over the next couple of months.
There are some misimpressions
about the relationship between
interest rates and housing activity.
If interest rates are rising because
the economy is growing-and
real incomes are growing with
it-then housing does fine as
the rise in income covers the
additional payment on the mortgage
resulting from higher rates.
This is, in part, behind our thematic
description of what we have expected
for 2015: "The Economy Drags
Housing Upward." We expected the
ABA BANKING JOURNAL | sEpTEmBEr/OcTOBEr 2015
3 million jobs produced in 2014 to be
paired with rising incomes in 2015,
which seems to be occurring. This
in turn would increase household
formation, which is occurring; which
would increase demand for housing,
which is occurring. Particularly
important has been the rapidly
improving employment of 25- to
34-year-olds. Interest rates have risen
modestly, but housing is improving.
There are other aspects of the
relationship of interest rates to
housing. If rates are rising because
inflation expectations are rising,
households appear to view housing
as an intermediate term inflation
hedge and housing does fine.
If rates are rising because the
central bank perceives inflation
risks and is acting to slow the
economy then employment and
incomes slow and the number of
homes sold falls, not prices.
Nominal interest rates are not directly
related to nominal house prices.
In periods when rates rise rapidly
in a short time period, incomes
can't adjust and home sales fall,
not prices. This was the sequence
of events in the rapid rate rises
of 1994-1995, 1999-2000 and 2013.
Our expectation is that Fed
policymakers are fully aware of this
relationship and it is one factor in
their thinking, since they comment on
the state of housing in each of their
post-meeting releases. We believe
that they will change policy rates
slowly and that, in general, mortgage
rates will be low for long as the short
rates rise faster than long rates and
the yield curve flattens. The Fed is,
however, already tightening policy
as their purchase of replacement
for maturing securities is shortening
the duration of their portfolio. This
is a reversal of Operation Twist
and constitutes tightening.
Considering all these relationships,
we think housing will continue
improving at least through 2017 in
a modestly rising rate environment.
Currently the biggest constraint
in some markets is the lack of
supply. New home construction is
still well below what demographics
would suggest is normal. It will be
a couple of years at least before
construction reaches that level
and in the meantime sales will
continue to rise incrementally and
prices will rise as The Economy
Drags Housing Upward. For the
risk managers reading this, note
that we are about at the seven year
mark of this expansion. The postWorld War II average is around
six years and our longest one
was 10 years. Just sayin'.
DoUGlAs G. DUNcAN is SVP
and chief economist at
Table of Contents for the Digital Edition of ABA Banking Journal - September/October 2015
POISED AND PROACTIVE ON THE FARM
MEETING CUSTOMERS WHERE THEY ARE
INVESTING IN STRONG RURAL COMMUNITIES
ABA COMPLIANCE CENTER INBOX
BANKS IN INSURANCE
REAL ESTATE LENDING
FROM THE STATES
INNOVATIONS IN SOCIAL RESPONSIBILITY
INDEX OF ADVERTISERS
ABA Banking Journal - September/October 2015
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