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Mortgage rates flat, homebuilders starting to feel effects of higher rates

The recent bond market sell-off bumps up mortgage rates again

Mortgage rates are the lifeblood of the housing market, which is why Bernanke and the Fed began conducting quantitative easing (or QE) in the first place. Lower rates allow homeowners to refinance, which increases their disposable income and helps stimulate economic growth. Lower rates enable first-time homebuyers 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 accounts for some 70% of the U.S. economy, and consumption 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.

Mortgage RatesEnlarge Graph

The bond market seems to be in a tight range

Bonds hit their lows the week of July 4, as a stronger-than-expected jobs report met with a thin market. Many senior traders had taken off Friday, July 5, which meant that most desks were under-staffed. I would almost put an asterisk by that 2.74% print. At the moment, it looks like the ten-year bond yield is in a range of 2.48% to 2.58%.

Effect on homebuilders

Homebuilder stocks, such as Lennar (LEN), Toll Brothers  (TOL), Standard Pacific (SPF), PulteGroup (PHM), and KB Home (KBH), have rallied strongly over the past year, but they’ve given up ground since Q1 earnings. Last week, they fell on the back of earnings announcements—particularly from Pulte, which reported negative order growth. They blamed higher interest rates on the drop, but believe the secular (long-term) story remains.

Given that the economy could have depressed household formation numbers, there’s real pent-up demand for housing. Housing starts have been below historical averages for the past ten years. With low mortgage rates and increasing demand, and a strengthening economy, homebuilders now have the wind at their backs. The builders that have exposure to the red-hot West Coast market did very well. For homebuilders, the top-down macro picture looks good.