The Less the Fed Knows, the Better for Housing

 | Apr 19, 2017 | 3:00 PM EDT
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It's only been two weeks since I addressed housing and homebuilding, but given the season and events that have transpired during the interim, it's appropriate to consider the issue again. 

In the past two weeks, the 10-year U.S. Treasury yield has declined by about 18 basis points, from about 2.38% to 2.20%. It was as low as 2.17% a few days ago. The 30-year fixed conventional conforming mortgage rate has declined by a similar amount, which has marginally increased home purchase affordability and allowed homebuilders' stocks to increase further. 

The two builders I've been focusing on for the past year are Hovnanian Enterprises (HOV) and Beazer Homes BZH because of their concentration on entry-level homes and the fact that first-time homebuyers are the most sensitive to mortgage rates. 

During the past two weeks, Hovnanian and Beazer have risen about 5.5% and 6.5%, respectively. 

I expect all of these trends will continue and accelerate in the immediate and throughout the spring and summer housing seasons. 

Although there are more reasons why I believe this to be the probable trajectory than I can discuss here, the principal reasons are an extension of what I discussed two weeks ago and have written about on many occasions over the past several years. 

First, there are the FOMC's fixation on "normalizing" interest rates, monetary policy broadly and now the size and composition of the Fed's balance sheet, to the exclusion of considering the state of the economy. 

Fed Vice Chair Stanley Fischer gave a speech two days ago in which he discussed what he believed the bond market's reaction would be to the Fed beginning the process of shrinking its balance sheet. The Fed would do this by selling holdings of mortgage-backed securities and long-dated Treasuries acquired during the quantitative easing policy initiatives. 

The gist of his comments was that the bond market should not respond poorly and repeat the "taper tantrum" that followed then-Fed Chair Ben Bernanke's interest in beginning the process of reducing the purchases of Treasuries and mortgages in 2013. 

That assessment is fine. The issue is with its timing. 

The old saying, "If it ain't broke, don't fix it," applies here. 

Nobody, other than the FOMC members themselves, is concerned at this point about the size of the Fed's balance sheet. 

Bringing it up now as an issue is counterproductive because it raises concerns by bond market participants about the awareness FOMC members have about the real state of the economy, and thus their ability to prioritize what appropriate policy and communication concerning such should be. 

As concerns the real state of the economy, the best aggregate depiction of it is the Atlanta Fed's GDPNow estimate of 0.5% real annualized GDP growth for the first quarter of 2017. It has collapsed in the past few months from the 3.25% estimate of mid-February. 

More importantly however, is the fact that the model now accounts for the residual seasonality adjustment that was applied to first-quarter GDP estimates after the repeated occurrence of low first-quarter GDP growth rates became an issue in 2015, which I discussed in several columns at the time. 

The germane point now is that, even after inserting an upward adjuster for first-quarter growth, it's still coming low enough not only to warrant concern about the economy by market participants, but mandate some kind of response by FOMC members. 

That response should include not only an acknowledgment of awareness of the situation but be evidenced further in not discussing things like shrinking the Fed's balance sheet. 

The totality of communications coming from FOMC members, however, suggests they are unaware of the immediate state of the economy, or that they don't think it's an issue and are assuming it is temporary. 

Regardless of what the reasoning is, I think it's probable that it is at least partially responsible for declining long-end yields as bond traders' concerns about awareness by FOMC members increases. 

I also do not expect that to change any time soon and that long-end Treasury yields and mortgage rates will continue to decline, stimulating housing activity and positive performance of homebuilders' stocks, at least for those with a focus on entry-level housing.

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