Mortgage rates are the lifeblood of the housing market, which is why the Fed began conducting quantitative easing (or QE) in the first place. Lower rates allow home owners to refinance, which increases their disposable income and helps stimulate economic growth. Lower rates enable the first-time home buyer to move out of an apartment and into a house, which means higher consumption (and good things for home improvement retailers, like Home Depot and Lowe’s). Consumption is some 70% of the U.S. economy, and it has been depressed since the housing bubble burst. The Federal Reserve would prefer to keep rates as low as possible for as long as possible.
The sell-off in the bond market has been swift
Mortgage rates have been trading in a narrow range of 3.4% to 3.75% for most of this year. After bottoming in late April, rates have increased as investors pile into the equity markets. Q1 earnings were generally good, and the economic data has not been weak enough to cause fears of another recession. Next week we have the FOMC meeting and the Street will be looking for language regarding the end of quantitative easing. Since Bernake testified in front of Congress a few weeks ago, the market has started to discount a tapering of quantitative easing by the end of the year.
As the bond market has stabilized, so have borrowing rates. The average 30-year fixed rate mortgage increased by an astounding 35 basis points the week ending May 31st, and went out at 4.1%. Last week, mortgage rates fell back below 4% to settle at 3.94%. The question of what caused rates to spike is still a bit of a mystery. While this is a substantial increase over the last few weeks, rates are still very low by historical standards.
Effect on home builders
Home builder stocks, such as Lennar (LEN), Toll Brothers (TOL), or KB Homes (KBH), have rallied strongly over the past year, with the Homebuilder ETF (XHB) rising smartly. As real estate prices have rebounded, orders have increased for builders, with some reporting year-over-year increases of 50% or more. Lower mortgage rates will certainly increase demand, and with the first-time home buyer beginning to return, the move-up buyer who is looking for their dream home will be able to sell their starter home.
Given that household formation numbers have been depressed due to the economy, there is real pent-up demand for housing. Housing starts have been below historical averages for the past 10 years. With low mortgage rates, increasing demand, and a strengthening economy, home builders now have the wind at their backs. Earlier this month, we heard from numerous home builders, including Lennar (LEN), PulteGroup (PHM), Ryland (RYL), NVR (NVR) and Meritage (MTH). Generally, home builders reported good earnings, with the exception of NVR, which is more East Coast focused. The builders that have exposure to the red-hot West Coast market did very well.
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