From Westpac Institutional Bank comes research arguing that market expectations of Fed tapering, which has seen the 30-year mortgage rate rise by 115bps since November 2012, putting at risk the housing market recovery:
Following the 18–19 June FOMC meeting, markets became increasingly concerned that the Fed may taper its asset purchases as early as September. The 10yr Treasury yield subsequently rose from 2.18% to a 25 June high of 2.61%, now 2.50%. This was a material move in its own right, but all the more so given it followed a 55bp rise ahead of the meeting (from the 2 May low of 1.63%). As is almost always the case, market participants had front-run the Fed, pricing in expectations of tapering based off a more hawkish tone from many Fed speakers.
To be clear, by and large, the change in tone amongst the FOMC voters has not signalled an outright hawkish shift based on activity and inflation data. Rather, we have seen an adjustment to the Fed’s reaction function, with a greater skew towards the potential risks of alternative easing over its benefits. The Fed still clearly believes that reducing the flow of new purchases will not tighten policy (because it will still lead to an increase in the stock of assets held). The dramatic change in market yields is clearly at odds with this thesis.
This point is made all the more clear when one considers market rates for end borrowers. In this instance, we focus on Freddie Mac’s 30-year mortgage rate. The reaction of the 30-year rate to the shift in Fed expectations was stark: it rose by 53bps in the week to 28 June. This left the 30-year mortgage rate some 115bps above its November 2012 low.
Needless to say, a 115bp increase in the cost of funds has a material impact on housing affordability, materially reducing the size of the loan that can be taken on by a potential buyer for a given monthly outlay. Further, it reduces the windfall discretionary income gain on offer to US households from refinancing, reducing the incentive to do so.
While the US housing market rallied strongly through 2012 and into 2013, it remains in a historically weak state, susceptible to shocks (such as a material rise in borrowing costs).
Initial evidence from weekly mortgage application data suggests that the recent rise in the 30-year rate has had a substantial impact on refinancing activity, with a 35% decline in activity seen since 10 May (now 42% off the late-2012 peak; on a 4-week moving average basis). The year-long uptrend in purchase approvals has also abated, with activity down 2.6% since the beginning of May.
Only time will tell if the housing market is strong enough to weather this tightening in credit conditions. For us, weak end demand outside of the housing market (immediately apparent from Q1 GDP and Q2 partials), the recent softening in labour market outcomes (away from the 200k monthly job growth target of the Fed), and the substantial rise in the mortgage rate all point to a disappointing second half of 2013 (not to mention material downside risks). As a result, we continue to believe tapering asset purchases in coming months would be ill advised.
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness.
Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.
