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 home owners to refiance, which increases their disposable income and helps stimulate economic growth. Lower rates enable first-time home buyers 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.
The jobs-report sell-off may have been overdone
Bonds hit their lows the week of July 4 as a stronger-than-expected jobs report was met with a thin market. Many senior traders had taken off Friday, July 5 which meant that most desks were under-staffed. Moves tend to get exaggerated when markets are thin (meaning there are few participants and thus low volume). Ben Bernanke’s Humphey-Hawkins testimony was relatively dovish, which helped put a bid under bonds.
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, 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 first-time homebuyers beginning to return, move-up buyers who are looking for their dream home will be able to sell their starter home.
Given that the economy could have depressed household formation numbers, there is 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. Generally, homebuilders reported good earnings, with the exception of NVR, which focuses more on the East Coast. The builders that have exposure to the red hot West Coast market did very well. For homebuilders, the top-down macro picture looks good.
The fear for homebuilders has been that the 105 basis point rise in rates will cool off demand for new homes. Three recent data points show this hasn’t been the case. Both Lennar and KB Home reported second quarter earnings and said that the increase in rates is creating a sense of urgency with buyers. Finally, pending home sales (which are contract signings) increased 7% in May. So far, the increase in rates is not cooling housing demand. If anything a recovering jobs market will positively affect demand for new houses. Earnings reports from the homebuilders on a December 31 fiscal year will give more color on how the jump in rates has affected new home demand.
© 2013 Market Realist, Inc.