Mortgage rates are the lifeblood of the housing market. This is why the Fed began quantitative easing (or QE) in the first place. Lower rates allow homeowners to refinance. Refinancing increases homeowners’ disposable income. It also helps stimulate economic growth.
Lower rates let first-time homebuyers move out of an apartment and into a house. This means higher consumption and benefits for home improvement retailers like Home Depot and Lowe’s. Consumption accounts for ~70% of the U.S. economy.
Mortgage rates continue not to correlate with movements in the bond market
Over the past several months, mortgage rates and the ten-year bond yield have stopped correlating. Last week was no exception.
The average 30-year fixed-rate mortgage decreased 5 basis points to close at 4.19%. The ten-year bond sold off and yields increased 15 basis points.
Recently, mortgage rates have been stuck around 4.25% even though bonds have been rallying. The issue may be that originators are beginning to extend credit to borrowers that they would have turned down last year. Over the past year, the only loans that were getting done were conforming loans and high-quality jumbos.
Many originators are now beginning to originate stated income loans—not to be confused with liar loans of the subprime days. These loans will have a higher interest rate than a generic Fannie Mae 30-year loan. That could explain why mortgage rates increased. If this is the case, this could be the impact builders were waiting for. Tight credit has been a problem for builders for a long time.
Effect on homebuilders
Homebuilders—like Lennar (LEN), Toll Brothers (TOL), PulteGroup (PHM), and D.R. Horton (DHI)—have been reporting decent earnings. However, it appears that traffic is increasing in the previously dormant East Coast and Midwestern markets. The West Coast probably moved too quickly.
An alternate way to invest in the sector is through the SPDR S&P Homebuilders ETF (XHB). Given that the economy could have depressed household formation numbers, there’s real built-up demand for housing.