Morning Report: Is the Fed pushing home prices higher?

Vital Statistics:

S&P futures4,19813.8
Oil (WTI)65.33-0.77
10 year government bond yield 1.57%
30 year fixed rate mortgage 3.13%

Stocks are higher this morning on no real news. Bonds and MBS are up small.

Mortgage applications fell 4.2% last week as purchases increased 2% but refis fell 7%. “Mortgage applications decreased last week as mortgage rates increased to 3.18 percent,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Refinances dropped 7 percent as a result, driven by declines in both conventional and government refinance activity. “Purchase applications increased for the second time in three weeks, rebounding after a rather weak April with mostly weekly declines.”

The decrease in refinance activity makes some sense, but with home prices appreciating so rapidly, equity is being created at a rapid clip. This is a fertile environment for borrowers to do cash-out refis to pay off a HELOC or credit card debt.

Is the Fed’s policy of buying mortgage backed securities fueling the rise in home prices? At least some are making that argument. The Fed’s buying is pushing mortgage rates lower than they would otherwise be, and that is permitting people to buy more house than they otherwise would be able to. Even Boston Fed President Charles Evans thinks that the MBS purchases might be unnecessary at this point.

“The Federal Reserve’s asset purchases artificially lower interest rates and financing costs, which reinforces the buyer’s need to pay higher prices. It is even further detrimental because the higher price means that the buyer is borrowing more and taking on additional leverage,” said Michael O’Rourke, chief market strategist at JonesTrading, in an interview.

It is an interesting point, however in the context of close to $4 trillion in origination last year (according to the MBA) it is hard to imagine that $40 billion a month is moving the needle all that much. I have to imagine that competitive behavior between the big originators is having a much bigger impact.

Of course the bigger question is whether the Fed’s MBS purchases are necessary in the first place, and originators were fending off margin calls from their brokers on a daily basis a year ago, which was partially driven by the Fed’s buying.

I think it is a stretch however to link the Fed’s buying to home price appreciation. That is due to a fundamental supply / demand imbalance in the housing market, driven by over a decade of under-building. Once the COVID-19 driven supply shocks work their way through the system, we should see housing starts return to a level to meet the demand out there.

That said, does the Fed’s policy in general push up asset prices? I would argue that it does, however that goes back to the dual mandate, which is a law passed over 40 years ago. It says that the Fed must maximize employment in the context of controlling inflation. While a well-intentioned policy, like most everything the government does, there have been unintended consequences. In practice, the policy tells the Fed to keep the pedal to the metal as long as inflation (as measured by consumer prices) is behaving. What about asset price inflation? Doesn’t count. The dual mandate coincides with the mother of all bull markets in stocks, bonds, and real estate. The Fed inflated a stock bubble in the 9os, and inflated a residential real estate bubble in the aftermath. They now have a sovereign debt bubble (not just the Fed, central banks globally following the same asset support playbook). I don’t see how you can look at the German Bund with over 2 years of negative yields and think otherwise.

Speaking of COVID-19 driven supply shocks, it looks like lumber prices might have peaked. Descending lower highs are usually a technical signal that the party is over and it is time to find your coat and call your Uber.

Wall Street CEOs head to the Hill today to get grilled by Democrats over income inequality. Elizabeth Warren says it will be “fun.” Expect to see a focus on loan servicing.


Author: Brent Nyitray

In the physical sciences, knowledge is cumulative. In the financial markets, it is cyclical

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