Driving with one foot on the brake and pressing the accelerator pedal to the ground with the other. That describes the housing market, with the Federal Reserve pumping fuel into the system while supply and affordability constraints slow things down. This is costly to say the least; at worst, it risks serious overheating and malfunction.
Rising house prices are now getting attention in the mainstream television news and on the front pages of newspapers, not just in the business section. The story has progressed from a narrative of the exodus from cities shut down by the Covid-19 pandemic, sparking a struggle that has pushed the prices of existing homes up 23% in a year. Now shortages of building materials, land and labor have exacerbated the pressure, potentially slowing housing construction.
Throughout the saga, the Fed has provided liquidity to tankers by lowering its short-term interest rate target to near zero and buying $120 billion in securities a month since the spring of 2020 to counter the economic impact of the pandemic.
The swift, aggressive response from the monetary and fiscal authorities, including the passage of the $2.2 trillion Cares Act, resulted in the shortest-ever recession, which began in February 2020 and ended just two months later. National Bureau of Economic Research, the arbitrator of such cases, announced this last week.
While the recession officially ended 15 months ago, the central bank continues its emergency policy. As the Federal Open Market Committee meets next week to outline short-term policy, bond buying will certainly be an important topic as Fed Chair Jerome Powell said: in his congressional testimony on July 15.
One question many critics want to answer is whether the Fed will continue to buy $40 billion in mortgage-backed securities a month while the housing market is overheated. Powell testified that the impact of MBS purchases is not significantly different from that of the Fed’s monthly $80 billion purchases of Treasuries, as the bond market considers the two sectors to be similar.
To say $40 billion in net monthly mortgage bond purchases is actually an understatement, says Barry Habib, the founder and head of MBS Highway, a consulting firm. After factoring in the reinvestment of interest and principal payments homeowners make on their mortgages, plus cash flows from refinancing, the Fed is actually buying about $100 billion of MBS a month, he claims. He notes that the FOMC’s Policy Guidance now specifies purchases of “at least” those amounts from agency MBS and Treasuries.
Read more up and down Wall Street: Shares go from miserable to record in Topsy-Turvy Week
Habib estimates that the MBS purchases have cut mortgage rates by 25-35 basis points. (A basis point is 1/100th of a percentage point.) That amounts to a grant to creditworthy borrowers, who would qualify for conventional loans eligible for purchase by
and for larger, jumbo loans held by private lenders. But he notes that stopping Fed purchases would hurt borrowers who get FHA and VA-guaranteed loans, which are bought by Ginnie Mae. (Those government-sponsored companies pool the loans into mortgage-backed securities that can be purchased by investors, including the Fed.)
Anticipating the eventual end of central bank purchases, the market has already widened the yield differential on agency MBS versus comparable government bonds by about 20-30 basis points, said Walt Schmidt, head of mortgage strategies at FHN Financial, an institutional fixed-income firm. . But the broadening hasn’t been nearly as severe as it was during the “taper tantrum” of 2013, which he says began in the MBS sector, even before Fed chief Ben Bernanke said the Fed would begin phasing out its securities purchases.
What’s also different now is how blazing hot the housing market is. Builders can’t keep up with demand, as fiscal third quarter reports from
(ticker: DHI), the country’s largest builder by volume, suggests. While net earnings per share rose 78% year over year and beat analysts’ forecasts by 8%, the stock fell 2% on Thursday.
Future orders fell, not because of a slump in demand, but because the company is holding back sales. “Based on the stage of completion of our current homes and inventory, production schedules and capacity, we expect to continue to curb the pace of our sales orders,” said Bill Wheat, Chief Financial Officer of DR Horton, during the analyst conference call. , Reuters reported:.
The inability to keep up with demand is an enviable problem for any business. And Habib says the fundamentals of the housing market are strong due to the ‘explosion’ in births about 33 years ago. The then-born consumers are entering their peak years for starting families and buying homes. He adds that, partly because of less lax lending standards, the current situation is nothing like the bubble of the 2000s, when it was “one person who bought four houses” as speculation.
Shares of DR Horton are down 14% since their May peak, about average for the homebuilder group, which is suffering from tight inventories and high prices countering strong demand. While builders struggle to get enough materials, equipment and labor, the Fed agency can continue to buy MBS with dollars created with just a click of the mouse.
More money chasing too few goods is the textbook definition of inflation, which has been deemed “transient” by the Fed. An increasing number of central bank officials are beginning to argue that the time has come, or at least is approaching, to do more than just talk about phasing out annual bond purchases of $1.44 trillion.
The recent performance of construction stocks suggests the central bank is not helping by holding the accelerator pedal amid supply constraints.
Write to Randall W. Forsyth at email@example.com