The taper is too sharp

Last night US existing home sales went through the roof. From Calculated Risk:


Total existing-home sales, which are completed transactions that include single-family homes, townhomes, condominiums and co-ops, rose 4.2 percent to a seasonally adjusted annual rate of 5.18 million in May from 4.97 million in April, and is 12.9 percent above the 4.59 million-unit pace in May 2012.

Total housing inventory at the end of May rose 3.3 percent to 2.22 million existing homes available for sale, which represents a 5.1-month supply at the current sales pace, down from 5.2 months in April. Listed inventory is 10.1 percent below a year ago, when there was a 6.5-month supply.

House prices are now rising at double digit rates. It looks like a booming recovery and solid support for Bernanke’s taper.

But I just don’t buy it. You can’t fire off a US housing market recovery using historically low interest rates then expect it to be unaffected when rates suddenly revert to mean. It’s really that simple. Pimco’s Bill Gross agrees:

The real economy won’t follow the path the Fed thinks it will,” said Gross. “The chairman suggested yesterday that, once we get through this soft patch of fiscal austerity in the U.S., that the 3 percent growth number is indeed where we should be and where they expect we’ll be. We have our doubts at Pimco…“The chairman was rather dismissive in terms of mortgage rates,” Gross said. “To dismiss that increase in costs based on higher interest rates I think is not only dismissive but again not reflective of what may lie ahead in terms of housing prices and the real economy.”

And from housing specialist, Mark Hanson:

In 6 short weeks the market has priced out all of the Twist and QE-3 benefit and taken rates back to “nose-bleed” levels of mid-2010 through mid-2011.

Based on the change in mortgage rates from 3.5% to 4.75% in the past 6 weeks, the median CA house price of $324k, and typical debt-to-income ratio of 45% the chart below captures how much the real change in cost of ownership has increased in the past 6 weeks:


These are huge moves especially considering — when purchasing a house using a mortgage — most people buy based on “monthly payment and the maximum allowable debt-to-income ratio”.

I’ll readily admit that I’ve been behind the curve in the past twelve months on the US housing market recovery. But these kind of dramatic interest rate hikes are going to kill refinancing activity and retard new mortgages as well. That will slow the housing market. Stock market sell-offs come and go but housing slowdowns have deep impacts.

Perhaps if the global economy were stronger it would be smooth. But with a European recession, a deteriorating China and rising US dollar, I’m still not convinced that the Fed will even get to its taper.

Houses and Holes
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  1. Question – If bond markets continue to sell off and our RBA continue to drop the cash rate say another 100 basis points…is there a point where the standard variable mortgage rate went up anyway?

    • In theory but not in practice. The global economy would blow up first. Unless Australia is on the end of a crisis driving up only our bank funding costs – like a Chinese credit crunch.

      • migtronixMEMBER

        The rate itself may not go up per se but “effectively” it will because a lower cash rate will drive whoever is still left holding AUD to run for the exits, drop the dollar to below 7000 I’d suggest, and send petrol through the roof. Net effect on households? Screwed!

  2. The Fed’s attempt to taper ‘just right’ has been described as like trying to thread a needle. John Mauldin this week described it as trying to thread the needle by throwing a ball of wool across the room…while blindfolded.

  3. SweeperMEMBER

    I can’t work out why the market (especially bond market) is getting so worked up about Bernanke’s press conference. All he said was that the Fed would end its asset purchases mid way through next year if the economy is in line with forecasts. ie. nothing has changed. Stimulus is still open ended. There isn’t an upper limit to the amount of asset purchases – if the labor market doesn’t improve, they’ll keep buying assets until it does.

    • Because most of the traders in the bond market have not being playing it for yield per se but captial growth (very profitable and oft misunderstood).

      This is a bubble that has roots back as far as 1982 and the longer you go out the curve the stronger the gains (and losses). A 30 Treasury Yield will gain circa 30% for every 100 basis point drop in yields and same for the loss…

      So yeah, this could turn to custard REAL quick…

      • But why are bond traders fearing capital losses all of a sudden? The Fed is still committed to a 0% short rate through to at least 2015 (as far as statements have indicated).

        The bond market has got ahead of itself. Winding back purchases is not the same as bring forward the date that the short rate will be lifted. And QE has not lowered the term premium; because the term premium was lower before the current round of purchases. Now is probably a good time to buy bonds.

      • Now is not a good time to buy bonds IMO.

        The Fed and BOJ are not the buyers of last resort, they are the buyers of only resort, if they pull out there will be no-one left to buy the over priced bonds…

        Not saying they will of course, I just think this is all taking a bit of heat out of it…which is probably good…likely they will be back in a few weeks/months to save the day…

  4. Slightly O/T but I’m surprised you’ve used an engineering tool as a visual for an economics site – a tapered Reamer at that!

    Any freudian undertones there?

  5. I made about half a million USD following Mark Hanson around the internet and watching his short trades on DSL and FED.

  6. I don’t buy it either, H&H.

    What I want to know, is what is happening in each part of the US economy.

    The part with strangled land supply to its cities and high volatility in section and house prices; and the part with free land supply and stable prices.

    It is impossible to intelligently analyse “the US economy” without disaggregating it into sections first and then looking at where each section is headed, and then working out the result at the “USA national” level. Similar to our approach to analysing “the EU”. We need to know what California and Texas are doing just as much as we need to know what Germany and Spain are doing.

  7. “I’m still not convinced that the Fed will even get to its taper.”

    Bingo! They never actually intended to taper in the short term. This is the first of many attempts to desensitize the market for an eventual taper about 3 years from now (after the next US election).

    Sort of like the boy who cried wolf… eventually, everybody (in this case, financial market participants) stops listening.

    When the market no longer responds to “tapering speculation”, that’s when the tapering will begin.

    • migtronixMEMBER

      Its the “Taper we had to have” bwahahaha.

      Not until every last MBS backed property in the US is owned lock stock and barrel by the FED and its shareholders (JPM/GS/BofA/Barclays/Standard Charter/Lloyds of London/UBS/Deutsche Bank et al)

  8. Considering the $85 billion a month starting point why doesn’t he just taper it by $1 billion. If the financial markets go into a meltdown over a reduction of $1 billion a month then nothing will save us anyway.

    • migtronixMEMBER

      $1 billion injection == $1 trillion in leverage and rehypothecation. So, yeah, its a big deal when the whole system is so over levered