Feb152017

Will rising mortgage rates lead to housing stagflation?

Lower house prices due to higher mortgage rates still result in a higher cost of home ownership.

housing-stagflationEveryone shopping for a home wants to see lower prices. For most products, paying less for it means the buyer keeps more money to purchase other goods and services, but with houses, this isn’t necessarily the case. Most people borrow a great deal of money to buy a house, often 80% to 96.5% of the purchase price. In fact, the cost of borrowing money is largely what determines how much someone can borrow and bid to buy a house. (See: Your neighbor’s debt creates your home equity)

When mortgage rates go up, the cost of borrowing increases, and unless wages rise considerably, the cost of borrowing will increase faster than wages go up. (See: Will rising wages offset the impact of rising mortgage rates?)

If the borrowing costs rise faster than wages, then future buyers will be unable to borrow the large sums today’s buyers can borrow; thus home price appreciation will slow (or perhaps even reverse). It’s entirely possible that buyers to wait to buy later may pay less money, but will that provide them any real benefit?

Some potential homebuyers remain on the sidelines hoping today’s reflated housing bubble prices will come down. The people sitting on the sidelines believe lower prices will bring with it a lower cost of ownership, but it won’t work out that way. Even if prices fall due to rising mortgage rates, the cost of ownership will continue to rise.

housing_double_dipIn the real world, particularly in Coastal California where supply is tight, people borrow to the maximum limit allowable to obtain the highest quality of housing they can. There is no excess affordability to provide any buffer to the shock of rising mortgage rates.

When mortgage rates rise, people will continue to borrow to the limit of their income, so the cost of ownership will not fall. In fact, the cost of ownership will continue rising with wages, so the housing market will continue to endure high inflation.

Perhaps all-cash buyers will reap the benefits of lower house prices, but not necessarily. If house prices fall due to higher interest rates, all-cash buyers will pursue other investment opportunities providing higher risk-adjusted returns than residential real estate. So while all-cash buyers may get a better deal, they may not want to buy houses because they can find superior returns elsewhere.

What we may see over the course of several years is weak or falling home prices and rising ownership costs, the worst of both worlds in residential real estate.

Fed hike in March may be on table

Paul Davidson, USA TODAY 6:30 a.m. ET Feb. 11, 2017

Ho-hum. Another Federal Reserve meeting is slated for mid-March, but almost no one is expecting the central bank to raise interest rates again after lifting them in December for the first time in a year.

Don’t be so sure.

In a recent interview with Bloomberg TV, San Francisco Federal Reserve President John Williams suggested a March hike isn’t off the table. And Chicago Fed chief Charles Evans, a dove who typically refers to keep rates low to stimulate the economy, said he’s still officially forecasting two rate increases this year but could be comfortable with three.

In December, when the Fed lifted its benchmark rate for the first time in a year, central bank policymakers raised their median forecast to three hikes in 2017, up from their estimate of two previously. Many economists say those moves will be backloaded to the second half of the year, when President Trump’s proposed fiscal stimulus could begin to juice growth.

Does anyone really think Trump will propose or pass a big fiscal stimulus that will stimulate the economy this year? So far, I haven’t seen the proposal. In 2009 when Obama tried to do the same thing, the Republicans opposed it. At the time, the economy really needed the stimulus. Now, not so much. Why would fiscal conservatives in the Republican party go along with a big stimulus package? The hypocrisy would be obvious, even to their partisan supporters.

When Obama went to implement his stimulus package, he found a lack of shovel-ready projects to spend money on. Are there more projects waiting today? I doubt it. Even if Trump gets his Republican allies to pass a stimulus package, actually spending the money may not happen as quickly as everyone hopes.

Fed fund futures give just a 9% chance of a rate increase in March, but 50% odds for June.

Fed Chair Janet Yellen, however, also has said the generally falling unemployment rate, now at 4.8%, calls for pushing up rates to head off inflation as employers bid up wages to attract fewer available workers.

Actually, a little wage inflation would be the best thing we could do for growth. It would be far more effective that a wasteful government spending program.

And employment growth in January was strong, with 227,000 jobs added. A March increase would allow the Fed to spread out the three potential hikes throughout the year. Her testimony before a Senate committee Tuesday and a House panel Wednesday could clarify the outlook.

I rather doubt three rate hikes is going to happen.

Wait for price deflation?

I became well-known for advising people to wait out the deflation of the housing bubble of the 00s, so if I believed lower prices would benefit anyone, I would advise waiting, but that’s not the case today. The conditions during the last bubble were different in a good way for buyers. That housing bubble was going to deflate because millions of foreclosures flooded the market with supply and lowered both the price and the cost of ownership. That won’t happen during the deflation of the reflation recovery (aka housing stagflation) because lenders won’t flood the market with supply, and mortgage rates will go up, not down.

If buyers have no reason to expect a lower cost of ownership, they gain no real benefit from waiting. Perhaps waiting reduces their risk of taking a loss at resale, but it does nothing to make owning any cheaper.

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