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Things were starting to look pretty scary for housing up until a few weeks ago. There was a chance that some of the weakness was temporary. Last week’s strong Pending Home Sales report provided some hope, but we didn’t have any other big housing reports to validate the hope… until now.
New Home Sales were as low as 549k at the end of 2018. This was well below the post-crisis trend of improvement. A strong number at the end of January had to be taken with a grain of saltbecause it pertained to November’s sales, not to mention the fact that this data series is notoriously prone to revisions.
This week brought us December’s New Home Sales data, and while there was a negative revision to that strong November number, it fell into a nice line leading back to the previous trend as seen in the chart below. Granted, we’re just now back to the lower boundary of that growth trend, but things could definitely be worse.
In a separate report from the Census Bureau, New Residential Construction showed a similar uptick for Building Permits and Housing Starts (which refers to the breaking of ground on new construction).
At least part of the equation for the housing slump and recovery has been interest rates. Unlike stocks, which have closed much of the gap to 2018 highs, rates remain near the lowest levels in more than a year. Part of the reason for this is a softening in economic data. A strong economy can support higher rates, so economic weakness tends to coincide with rates falling.
The Employment Situation (aka the “jobs report”) is the most important piece of economic data as far as interest rates are concerned. When it’s weaker than expected, rates tend to fall. Friday’s jobs report was incredibly weak! Rates clearly should have fallen in response. They did exactly that at first, but paradoxically bounced higher as the morning continued.
Stocks were included in the chart above to show the correlation that’s frequently seen surrounding surprising economic data. Logically, bad economic news could prompt investors to sell stocks and buy bonds (buying bonds = lower rates). So why did some investors start selling bonds (pushing the blue line higher) even though stocks continued to fall?
It’s a bit anticlimactic to consider, but rates may simply have had enough of a good thing for the week. Thank central banks for that!
Economic data may paint a picture and suggest a logical range for interest rates, but more often than not, it’s central bank policy changes that cause the bigger movements inside those ranges. Both the Fed and the ECB (European Central Bank) have been fairly friendly toward bonds/rates recently. This week, it was the ECB’s turn. Thursday’s ECB Announcement and press conference helped rates improve at their fastest pace of the week.
Notice the reference to a “technical correction” in the chart above. This refers to trading that disregards fundamental data/news/events and instead relies only on the chart patterns for decision making. For instance if stocks/rates hit a certain ceiling multiple times, investors might assume another bounce will result in a similar amount of movement. As a result, they may trade in the implied direction as soon as it looks like other traders are doing the same thing. This likely contributed to ceilings in stock prices and bond yields (“rates”) early this week.
Just like there are technical ceilings, we also frequently see technical floors. To bring the discussion full circle, we could also argue that rates resisted a bigger move lower after the jobs report because it would have meant breaking below such a floor.
Despite the evidence for technical resistance, not everyone will be satisfied with that explanation. In their defense, it really is a lot to ask to believe chart patterns caused rates to ignore such a huge drop in the jobs count. For those left with raised eyebrows, consider the internal components of the jobs report. Not only did the unemployment rate fall back to 3.8%, but wage growth rose to another post-crisis high. Inflation may not be a huge concern at the moment, but investors will increasingly have to ask themselves how much higher wages can go without inflation eventually being pulled higher (higher inflation puts upward pressure on rates).
We won’t get any more central bank bombshells in the week ahead, but that’s only because the Fed is in a communications blackout in advance of its next big policy announcement in the following week. We will, however, get another round of fairly important economic data, and we’ve been looking toward this mid-March time frame for investors to become more willing to react to the data after taking things with a grain of salt surrounding the government shutdown. Bottom line: rate volatility could just be getting started.
Two weeks ago, the newsletter discussed why 2019 could actually be great for the housing market, despite downbeat reports and the likelihood of one more month of weakness for Existing Home Sales. That weakness showed up last week, but with it came a comment from the chief economist for the National Association of Realtors saying home sales were likely at a cyclical low.
As of Wednesday, we finally got the Pending Home Sales report showing the bounce we were looking for. Pending Sales momentum is a precursor for a bounce in the next Existing Home Sales report in a few weeks. That means there is indeed a chance we just saw a cyclical low.
Unfortunately, we also saw the beginning of a fairly abrupt move higher in rates on Wednesday. Early that morning, underlying bond markets (which dictate mortgage rates) began to look panicked. It wasn’t immediately clear what caused the move, although Brexit-related news was the leading candidate.
Why does Brexit news matter to US interest rates?
First off, US rates will always take some cues from major overseas markets. This is especially true of German and British sovereign debt. For instance, if British and German 10yr yields are spiking, US 10yr yields tend to experience some upward pressure as well (and US 10yr yields serve as key benchmark for mortgage rates).
Rates, in general, tend to benefit from uncertainty and economic headwinds. Brexit represents a major unknown in terms of its impact on the European economy. The sooner it happens and the harsher the deal is for Britain, the greater that uncertainty. Wednesday’s news suggested the deadline could be pushed back and a more favorable deal was still possible.
While the Brexit updates have generally pushed rates higher, they alone do not explain Wednesday’s market movement. Other explanations involved simultaneous congressional testimonies from Fed Chair Powell, Michael Cohen, and Robert Lighthizer (speaking about US/China trade relations–definitely a hot button for uncertainty).
The catch is that none of these testimonies had started by the time the bond market began losing its composure. That leaves us with one of the most frustrating explanations from a market-watching standpoint, but also one of the most common: sometimes trading momentum is its own reason for existence.
We do know that big trades started hitting the bond market right at 8:20am ET, which is an important opening bell for a certain group of bond traders. If this group comes into the market on any given day looking to make the same sorts of trades, rates can end up moving quickly without any apparent motivation from economic data or news.
This “glut” of trading demand was definitely a factor behind rising rates Wednesday morning. It wouldn’t necessarily be something worth discussing except that it started a chain reaction that lasted through the end of the week.
Rates were well on their way to recovering when Thursday morning’s GDP report came in stronger than expected. If anything, investors were on the lookout for the report to miss the mark due to the government shutdown. In general, if the 4th quarter of 2018 wasn’t as bad as investors feared, that would suggest another move higher in rates.
This is really when the chain reaction happened. Rates had been pushed high enough to definitively break outside the consolidation range seen in the red lines below. Such consolidation patterns often give way to breakouts that carry more momentum than average. It’s not unfair to say that bonds can feel pent-up in such ranges and subsequently look to release that pent-up energy.
Bottom line: rates frequently react to market fundamentals (economic data, news headlines, and other developments that speak to the economy). Sometimes, however, the fundamental explanations fall short and we’re left to observe so-called “technical” motivations (patterns in the charts and other purely mathematical assessments of what rates should do based on past precedent).
Bond traders were well aware of the consolidation range and the implication for a bigger move once it was broken. Without more panic surrounding Brexit, trade wars, and a GDP slump, it was only natural that the range breakout would take the unfriendlyform seen above.
Is this the end of the road for our nice run of low rates in 2019? It’s far too soon to conclude such things. Most traders are looking for the market to make bigger decisions in mid-March after the next Fed meeting. Between now and then, rather than plan on rates skyrocketing, a better baseline would be to shift the goalposts to something more horizontal, as seen in the following chart.
Charts in this newsletter tend to focus on 10yr Treasury yields because they are a benchmark for longer-term rates like mortgages. Movement in the Treasury market generally dictates the pace of mortgage rate movement. Plus, we can watch Treasuries move every second whereas mortgage lenders only change rates 1-2 times per day on average.
Much like the chart of 10yr Treasury yields above, mortgage rates are also at their highest levels in more than a month. That said, several news articles were out yesterday claiming the lowest rates in more than a year. What’s up with that?!
As is frequently the case when rates make big moves in the second half of any given week, the source of confusion is the methodology behind Freddie Mac’s weekly rate survey. Big news outlets rely on the Freddie survey as source material. There’s nothing wrong with that but it’s important to note that Freddie’s survey heavily favors Monday and Tuesday rate quotes while completely ignoring Thursday and Friday. If we look at actual lender rate sheet averages compared to Freddie’s weekly number, we see a line that looks much more like Treasury yields above. The implication is that the Freddie rate survey should jump noticeably next week, barring some unforeseen salvation for rates.
The Federal Reserve (aka “the Fed”) is the US central bank that sets policies relating to the flow of money. Even though they’ll be the first to admit they don’t have perfect control of the situation, their goals are to keep employment high, prices stable, and financial instability at bay. Because these goals are often at odds and because the Fed’s decisions have a big impact on financial markets, Fed policy changes are always closely watched.
Updates from the Fed are so closely watched, in fact, that markets are accustomed to digging through the Fed’s 3-week old meeting minutes for any clues about potential policy shifts. This week’s meeting minutes offered a few important clues and better framed the somewhat surprising Fed announcement at the end of January.
What was so surprising about the late-January Fed Announcement? Here’s the newsletter that covered it in more detail. The short version is that they were much more downbeatin their assessment of the economy, they dropped their recommendation for further gradual rate hikes, and they even hinted at an updated bond buying policy in the near future. Taken together, this was such an abrupt shift that it left traders scratching their heads.
It also left traders with much more clarity about how to trade. A downbeat Fed that is talking about holding rates steady and hinting at buying bonds?! That’s a clear “BUY” signal for both stocks and bonds.
To be clear, the Fed isn’t talking about buying bonds in the same way they were during their widely-criticized but arguably successful quantitative easing (QE) programs. QE purchases grew the Fed’s balance sheet, and they’re currently in the process of shrinking it (by letting their bond holdings mature without reinvesting the principal). This time around, the Fed is talking about stopping the shrinkage! Whenever they do that, it will mean all of the money they earn on their bond holdings can now be used to buy new bonds (bond buying = lower rates).
The Fed’s normal method of money market influence is to hike or cut its policy rate. While this has a profound effect on short-term interest rates (and a noticeable psychological effect on the stock market), its not nearly as effective as the balance sheet (aka “bond buying”) when it comes to longer-term rates. The relative impact of rate policy and bond buying policy can be seen at 2 key points in the past 2 months.
At the beginning of the year, Fed Chair Powell said the Fed is “sensitive to the message markets are sending.” In other words, they recognized that they’d eventually need to do something if the stock market continued to plummet. At the time, Powell was happy to reaffirm that the Fed’s bond portfolio would continue to shrink at regular intervals (i.e. no increase in bond buying on the horizon). The stock market was happy about the Fed implying slower rate hikes, but that wasn’t big news for longer-term bonds (like 10yr Treasury yields and mortgage-backed bonds). Thus stocks and rates moved higher together in January.
The January 30th Fed Announcement introduced the possibility of a shift in bond buying policy–something longer-term bonds COULD actually get excited about. The relative excitement can be seen as rates began falling again in February.
Now this week, we have confirmation from the January 30 meeting minutes that the Fed had an even more robust discussion about its balance sheet. By Friday, numerous Fed members were on the record talking about an end to balance sheet reduction in 2019–a far cry from Powell’s “steady as she goes” attitude in early January.
This brings us to the Fed’s relationship with the housing market. Whenever the Fed flips the switch on its balance sheet reduction plan, it will cause an immediate influx of substantial demand in the bond market. And again, bond market demand = lower rates (specifically, lower longer-term rates, like mortgages).
Connecting the dots, we’ve talked quite a bit in recent weeks about the role of mortgage rates in housing demand. True, it’s not the primary driver of the housing market, but it’s an important supporting actor that can tip the scales if other aspects of the market are on a fence.
Lawrence Yun, the Chief Economist for the National Association of Realtors agrees. Although January’s Existing Home Sales numbers didn’t get a boost from December’s rates, he said lower rates will “inevitably lead to more home sales.” In fact, he sees January’s numbers as a “cyclical low”–something I suggested would be the case in last week’s newsletter!
I’m telling you this because I want to be a cheerleader for the housing market. From an objective standpoint, there was a lot of uncertainty in the market at the end of 2018 due to stock losses and the government shutdown. It’s no surprise to see it carry over to January, and it would be no surprise to see a bit of a housing recovery now that the shutdown is over, stocks have bounced, and the Fed is suddenly feeling friendly.
The friendliness is not without risks though. Ultimately, the Fed’s friendliness depends on the state of the economy. When Fed Chair Powell delivers congressional testimony on the state of the economy next week, he’ll likely try to strike a balance between recent policy extremes by reiterating the Fed’s dependence on the economic data. If markets perceive him as being too upbeat about the economy or if he pushes back on his colleagues thoughts on the Fed’s balance sheet, it could put upward pressure on rates.