A Federal Reserve interest rate hike should stimulate the U.S. housing market, not dampen it.
Here's why. I wrote several columns during June and July outlining the rationale for first-time home buying to increase as a result of long-end U.S. Treasury yields and mortgage rates steadily declining to record lows between then and next spring.
But in the past two months long-end Treasury yields have rebounded strongly, with the 10-year bond moving to 1.6% from about 1.36%, and the 30-year to 2.25% from about 2.09%.
So does that kill the thesis? No. In fact, economic activity and market action comport with the thesis.
The principal reasons for Treasury market volatility are near-term uncertainty about monetary policy, the great difference of opinion by prominent bond market participants on what monetary policy should be and a myopic focus on individual economic data points by bond market participants being caused by these issues.
Even as these trends have been increasing for the past few months, especially as the key FOMC members have been publicly coalescing around support for rate hikes, mortgage rates have remained unchanged.
The increase in purchase-money mortgage originations, driven by the nascent re-entrance of first-time home buyers to the market, as evidenced in the new home sales for July, which I have addressed, is providing mortgage-backed securities liquidity and allowing for mortgage spreads over Treasury yields to decline even as Treasury yields increase.
I think those trends and trajectory will continue if the Fed continues to punt on rates -- and actually accelerate if the Fed raises rates.
There is a huge communications problem between the rationale being used to justify rate hikes and that being used to justify not hiking rates, and both are logically correct. The problem is not in the arguments on either side; it's in the differences between the justifications for those arguments.
The principal issue for monetary policy and its interaction with capital markets, and thus the real economy, continues to be the failure of the stimulus to be transmitted to the real economy.
Those wanting rate hikes are looking at the monetary inputs and stating that there's been enough stimulus added to afford for an increase in real economic activity, and doing more, or not reducing what's been supplied, will only risk causing asset bubbles and perhaps inflation rising too quickly soon.
Those opposing rate hikes are looking at real economic activity as indicated by current inflation and, although typically not stating such, stating that no matter how much monetary stimulus there's been to date, it still hasn't achieved its goal of a secular increase in aggregate economic activity. Thus, raising rates is inappropriate.
Both arguments are correct, but beyond the issue of why the monetary transmission mechanism has failed is the pragmatic issue of who bears the greatest burden of an increase in rates.
On the first point, the failure of transmission, there is universal agreement. That was the principal reason the Fed enacted a third round of quantitative easing with the goal of forcing mortgage rates down by buying agency mortgage-backed securities. This was an attempt to force the transmission of monetary policy past the banks and bond market and into the real economy. It wasn't very effective, and the Fed backed off that approach. The pragmatic reality is that monetary policy impacts the real economy as a "last in, first out" scheme. That means that raising rates has the most negative impact on those who have least benefited from lower rates.
Private sector demand has been exhausted because aggregate consumer incomes are already fully collateralized to servicing existing debts. Raising rates only makes that situation worse and actually results in a negative economic impact.
However, the silver lining of a Fed rate hike is that bond market participants, aware of this logic, will probably drive long-end yields down rather than up, and that will cause mortgage rates to decline even faster -- to record lows.
Paradoxically, that means that if you want housing to do well next spring you should be rooting for the Fed to raise rates soon, with the unintended consequence of it actually being stimulative for the housing market.
