Mortgage shock lands on the US property

BofA on the fruits of the Fed for US property.

The worst affordability since the housing “bubble” burst

The increase in the 30yr mortgage rate this year has been rapid, surging 160bp in just about 3 months. The benchmark 10y Treasury yield has also risen, but by 94bp. In other words, there has also been a significant widening in mortgage spreads, by 66bp to243bp. This could be explained by the Fed’s accelerated pivot from QE to QT, the latter of which we expect will be announced at the next FOMC meeting in May.

The move higher in rates means that an already significant affordability shock will be worse. Just a few weeks ago we took a look at the NAR affordability index and found that the 4.22% on average rate through mid-March, would lead to a record affordability decline of more than-25% yoy. Refreshing the data, that decline now looks closer to-30% yoy (Exhibit 1). And it will probably be even worse than that given the considerable momentum behind home prices, which actually picked up to begin this year with Case-Shiller national home prices accelerating 1.6% mom and 19.2% yoy in January. This move would bring the level of affordability to the lowest since 2007, when the housing bubble was bursting.

Housing affordability tends to lead the trajectory of existing home sales by about half a year. For illustrative purposes, we can draw up a scenario where the existing home sales trajectory matches affordability. This would suggest existing home sales falls below a 4.4mn saar pace by September, averaging 5.26mn saar over the first 9 months of 2022. That said, the relationship between affordability and existing home sales is imprecise. As a result, we view this as more of a bear case than the base case.

The hit to affordability will likely be only one part of the picture. Another major reason for existing home sales to pull back will be because of the mortgage rate“lock-in” effect. Remember that existing home sales is a measure of housing turnover and will partially reflect owner-occupied households trading up, down, or moving regions. It is likely that the overwhelming majority of these households are paying a much lower mortgage rate than the current market rate, which provides a huge disincentive to move. As a result, demand and supply would head lower. There are signs of this buyer/seller base already withdrawing: according to the NAR existing home sales data, the share of buyers that were previous homeowners slid to 35%in February from 42% in January. Meanwhile, current existing home inventories are already at record lows with months supply SA at 1.9 and actual levels at 966k units.

There should be positive offsets for the existing home sales trajectory. The move higher in rates could lead to a pull forward in demand, which could underpin near-term sales. The pandemic has also led to a shift towards remote-work, which could help facilitate migration from high-cost areas to low-cost areas where homeownership is more affordable. In addition, household balance sheets are the strongest they’ve ever been with net worth surging to 809% of disposable income, and debt service ratios running near historically low levels. Labor markets are booming as well, with job growth averaging nearly 600k over the last 6 months alongside accelerating wage growth. Finally, there are demographic tailwinds with Millennials now in their prime home-buying years. For now, were main comfortable with our call for existing home sales to fall by 10% in 2022 to 5.6mn, but we acknowledge the growing downside risks from worsening affordability.

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