Tuesday, January 23, 2018

Recent increased interest rates probably won't derail housing

 - by New Deal democrat

In the last couple of weeks, long term interest rates have moved significantly higher.  As of yesterday, the 10 year bond closed at roughly 2.66%, its highest yield in 3 1/2 years.  If this move is sustained for a few months, I expect it to have an effect on the housing market, but how much?

Here is an updated variation on a graph I have run many times over the last 5 years:  the YoY change in the 10 year treasury bond, inverted (blue), versus the YoY% change in housing permits for single family homes (green). I'll explain the red line below:

In general, the housing market responds first and foremost to interest rates. So when interest rates rise (shown as a negative YoY in the graph), permits historically have fallen.

But in this expansion, permits have responded by decelerating increases rather than by actual declines. A decent estimate is that the demographic tailwind of the large Millennial generation arriving at home-buying age is that it has added 7.5% growth YoY vs. what we would otherwise expect. That is what is shown by the red line in the graph above.

I still expect a few months of restrained *YoY* growth (not m/m, which has already increased to new highs) before improvement in that metric.

But the above graph does not show the uptick in rates this month, so the below is the same graph, limited to the last year, but with daily values in treasury rates:

The bottom line is that the recent increase in rates isn't enough to derail the housing market.  I suspect that rates would have to go above their 2013 high of 3.03% for that to happen.

Finally, there is another factor to consider, which is monthly mortgage payments.  As I pointed out several months ago, monthly mortgage payments got downright cheap at the bottom of the housing market, and still are quite reasonable compared with their 2005 highs.  Here's an update graph of real, inflation-adjusted mortgage payments from Core Logic:

This is probably also a factor in why housing has responded relatively tepidly to changes in interest rates. Especially with soaring rents and constrained supply, owning is -- relative to renting -- still a bargain.  It will probably take another 10% increase in real monthly carrying costs for that to become at all comparable to its surge during the housing bubble.

Saturday, January 20, 2018

Weekly Indicators for January 15 - 19 at XE.com.

 - by New Deal democrat

My Weekly Indicators post is up at XE.com.

The new 40 year low in jobless claims was overshadowed by the jump in interest rates. 

Friday, January 19, 2018

The intensity of Fed rate hikes as a precursor to recessions

 - by New Deal democrat

Between 1931 and the mid-1950s, the yield curve never inverted, and yet there were 5 recessions (1938, 1945, 1948, 1950, and 1954). In particular, the 1938 "recession within the depression" was one of the worst of the 20th century.

So in a low inflation and low interest rate environment, where the yield curve may not invert, are there other signals from the bond market that are reasonably reliable?

A month ago I noted that spreads between corporate bonds and government securities have a very spotting record during more deflationary eras.

Today let's approach the issue from another angle. Is there something about the *intensity* of Fed moves that correlates with recessions?  Below is a graph of the YoY change in the Fed funds rate since 1955, minus 1.5%, so that a YoY increase of 1.5% in the Fed funds rate = 0:

Twelve to eighteen months prior to 8 of the last 9 recessions, the Fed increased rates YoY by 1.5% or more.There were 4 false positives, two of which involved hikes of 1.5% or 1.75% (1962 and 1966), and one potentially false negative (a 1.5% increase in the Fed funds rate preceded the 1957 recession by 21 months). In the case of the false positives, there were slowdowns in GDP growth even though there was no outright recession.

So, in the most generous interpretation, a YoY Fed rate hike of 1.5% or more is almost certain to be followed by a slowdown, and more often than not by a recession.  That's pretty decent even if not perfect.

That suggests that the very gradual Fed rate hikes of the last several years need not give us much concern. And indeed there is one (and only one) episode in the last 60 years that seems to bear this out.  In the first half of the 1960s, the Fed gradually raised rates from 1% to 5% (blue line in the graph below):

These rate hikes coincided with economic growth of between 5% to 10% annually! Only when the Fed increased the pace of their hikes beginning in late 1965 did a slowdown occur, as shown by annualized real GDP in the graph below:

Of course, correlation is not causation, and one obvious candidate for causation is that the Fed is simply reacting to an increase in inflation either already underway or correctly anticipated. To check this, the below two graphs show the YoY% change in inflation, together with the YoY change in the Fed funds rates:

Indeed, with a few exceptions, sharp 1.5%+ increases in the Fed funds rate YoY tend to occur along with equally sharp increases in inflation.

But there are several exceptions, all having to do with the low interest rate environment.

In the first place, as recently as 2011, inflation rose from 1% to 3.8%. The Fed stood pat. No recession occurred.

Now let's take a look at the 1950s:

Here we have two completely different examples.  In the period of 1954-57, the Fed hiked rates by a total of 2.25% while inflation went from negative to just under 4%. In contrast, during the inflationary 1960s-1980s period, the Fed raised rates by 2% or more multiple times without a recession ensuing.

 In contrast, in the 1958-60 period, inflation remained under 2%, but the Fed aggressively raised rates from under 1% to 4%, and a recession ensured.

What we are left with is, even without looking at the yield curve, we can say that *either* a sharp rise in interest rates, *or* a sharp rise in inflation, almost always precedes to a slowdown, and more often than not precedes a recession.  Right now, we have neither.

Thursday, January 18, 2018

A quick note on housing permits and starts

 - by New Deal democrat

I'll do a more detailed analysis next week, once new home sales are reported, but for now a quick synopsis about December housing permits and starts:

  • single family permits (the least volatile, most forward looking metric) made another new high
  • total permits are just slightly below their October high
  • the three month moving average of the more volatile housing starts made a new high save for the three month average from 10 months ago.

YoY interest rates are no longer a drag on the market, and I am impressed with the strength of the demographic tailwind. While not perfect, this was a very positive report.