Interest Rates Shift Upward

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By David F. Seiders, Chief Economist, National Association of Home Builders

Long-term IRs shift upward
Long-term interest rates have been stubbornly low in recent years, despite the large increase in short-term interest rates (3.5 percentage points) implemented by the Federal Reserve since mid-2004. Indeed, long-term bond and mortgage rates actually held below their mid-2004 levels through February, and flat (or inverted) yield curves became commonplace around the globe.

The mood in domestic and global bond markets shifted abruptly in the early days of March, and the 10-year Treasury yield moved up by about 20 basis points in short order (to about 4.75 percent). The catalyst for change came primarily from abroad, as various foreign central banks (including the European Central Bank) raised their interest rate targets and the Bank of Japan talked publicly about putting an end to its long-standing quantitative easing process.

These moves raised questions in the investment community about maintenance of huge flows of global capital into U.S. securities markets, and long-term rates in the U.S. shot up immediately.

The recent up shift in long-term rates has simply returned them to mid-2004 levels. The Treasury yield curve now is essentially flat from six months out, and another quarter-point hike by the Fed at the March 28 FOMC meeting should flatten the short end of the curve. We appear to be headed toward a more sustainable yield structure than we’ve seen for several years, and further (modest) increases in long-term rates are likely over the balance of the year.

Appreciation slowing, but affordability eroding
House price appreciation apparently topped out around mid-2005, but the slowdown has not yet stemmed the systematic erosion of housing affordability that has sapped the strength of housing demand in recent times.

The purchase-only component of the House Price Index produced by the Office of Federal Housing Enterprise Oversight (OFHEO) is the best available measure of house price appreciation. This measure increased at a year-over-year pace of 10.8 percent in the final quarter of 2005, down from a peak of 11.5 percent in the second quarter.

The median price of existing single-family homes lost a bit of forward momentum as 2005 drew to a close, but this series still recorded a hefty 13.1 percent year-over-year advance in January.

The accumulation of rapid house price gains over a period of years, along with a gradual increase in mortgage interest rates since mid-2005, have continued to weigh on affordability in the existing-home market. Indeed, the
composite Affordability Index by the National Association of Realtors was down by 13.3 percent in January (year-over-year), and that decline followed substantial deterioration in 2004 and 2005.

Unsold new home inventories high
According to the Census Bureau, the inventory of new homes for sale reached a record level in January, and the months’ supply (at the January sales pace) moved above five for the first time in almost a decade. Furthermore, the median length of time that completed new homes sat on the market moved up to 4.5 months.

The Census Bureau’s new-home inventory estimates include units that are for sale but not yet started, a feature that takes some sting out of the inventory “overhang.” However, the inventory of units completed or under construction also is at a record level. Furthermore, home sales that are subsequently cancelled never get back into the government’s inventory estimates, and it’s clear that cancellations have been on the rise recently.

In February, NAHB surveyed nearly 500 single-family builders about unsold inventories (excluding units not yet started and including units handed back to builders through cancellations). More than one-third of the respondents said their inventories were higher than six months earlier, while less than one-fifth said their inventories had come down over that period. The net percentage reporting higher inventories was particularly high in the West and among builders starting more than 25 units per year.

Sales cancellations on rise
In NAHB’s February survey, 20 percent of single-family builders said their cancellation rate was higher in January than six months earlier, while only 8 percent said their cancellation rate was down over that period.

A supplementary NAHB canvass of about 30 large single-family home builders showed that, in January, cancellation rates (cancellations as a percent of sales backlog) were up by about one-third, on average, from historically low levels a year earlier. That trend, if it continues, accentuates the need for builders to control speculative building during the period ahead and to employ incentives to support sales and limit cancellations.

The National Association of Home Builders is a Washington-based trade association whose mission is to enhance the climate for housing and the building industry. Chief among NAHB’s goals is providing and expanding opportunities for all consumers to have safe, decent and affordable housing.

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