🚩Rates have risen again. What's the reason behind it? 10.02-10.06.23🚩
MARKET MOVING NEWS THIS WEEK
October 2, 2023
The bond market currently reflects a decline of over 50 points as I provide this update, which is not the ideal start to the week. This comes on the heels of notable increases in mortgage rates in recent weeks, impacting buyer demand, builder sentiment, and homebuyers nationwide. However, there is a silver lining in the fact that interest rates appear to be peaking, and we have reason to anticipate improvements in rates over the next year. This challenging mortgage rate environment is expected to be temporary.
UBS has indicated that high-quality bonds are likely to outperform cash in various scenarios presented by the Fed in the coming 6-12 months, which is encouraging news for bond investors. As bond prices rise, historically, mortgage rates tend to decrease. Hence, investor confidence plays a significant role, with the selling of bonds contributing to a decrease in their prices. The recent 50+ point drop in the bond market translates to yet another increase in mortgage rates.
What potential developments could unfold in the coming year?
"Numerous investors opted to sell high-quality bonds during the post-financial crisis era characterized by ultra-low interest rates. Nonetheless, we believe that high-quality debt plays a significant role in portfolios, serving both as a source of returns and a long-term diversification tool. Based on our capital market assumptions, we anticipate that bonds, as a whole, could yield total returns ranging from 15% to 25% over the upcoming five years, with variations dependent on factors such as currency and credit quality.
Historical data further supports this notion. U.S. government bonds, for instance, have surpassed USD cash returns in approximately 83% of five-year periods since 1925. Additionally, in examining all five-year periods from January 1977 onwards (which coincides with the availability of data on a higher 2-year than 10-year Treasury yield, known as curve inversion), U.S. government bonds have outperformed in roughly 90% of cases. This figure rises to 97% when considering five-year periods that commenced with a yield curve inversion.
In terms of upcoming developments, we anticipate significant news in the labor sector. Beginning on Tuesday, there will be updates on job openings via the JOLTS report for August. Wednesday will feature ADP's Employment Report for September, focusing on private payrolls, while the latest Jobless Claims data will be reported on Thursday. The most noteworthy headline is expected on Friday, with the release of September's Jobs Report by the Bureau of Labor Statistics. This comprehensive report will encompass Non-farm Payrolls and the Unemployment Rate, making it a key point of interest."
A brief overview of last week's headlines:
Home prices in the U.S. have continued to climb, as reported by both the Case-Shiller Home Price Index and the Federal Housing Finance Agency's House Price Index in July. It's worth noting that the FHFA's index focuses on lower-priced homes and excludes cash buyers and jumbo loans, potentially leading to variations in reported figures. Home values have now reached record highs, rebounding from the 2022 dip, and are projected to appreciate by 5-9% this year.
Initial jobless claims saw a slight increase, although the overall volume of first-time filings remains relatively low, indicating steady employment retention. Continuing claims have been on a downward trajectory, suggesting a combination of individuals finding new employment opportunities and the expiration of benefits. The Federal Reserve is closely monitoring labor market data as they consider potential future rate hikes, with their next rate decision scheduled for November 1.
In summary, the housing market continues to see price growth, while the labor market remains stable. The Federal Reserve is carefully observing these factors for potential adjustments in interest rates.
Regarding August's Personal Consumption Expenditures (PCE), headline inflation registered a 0.4% increase, slightly below expectations, resulting in a year-over-year rise from 3.4% to 3.5% due to previous reporting adjustments. Core PCE, which excludes volatile food and energy prices, experienced a 0.1% uptick in August, with the year-over-year figure declining from 4.3% to 3.9% – its lowest level in two years. Despite persistent inflation concerns, the rate has significantly improved from last year's peak of 7.1% and currently stands at 3.5% for headline inflation. An annualization of the last six months of Core PCE readings yields 2.9%, a slight reduction from the previous 3.4% and marginally above the Fed's 2% target.
The Federal Reserve's decision regarding potential future rate hikes will be made during their upcoming meeting on November 1.
Pending Home Sales experienced a 7.1% decline from July to August and were 18.7% lower compared to the previous year, suggesting potential reduced closings in September. Some prospective homebuyers are postponing purchases due to elevated interest rates and limited inventory. The housing market is eagerly awaiting increased inventory levels and improved interest rates to stimulate activity. Notably, 26% of homebuyers have expressed fatigue from contending with multiple offer situations, a persistent challenge in many markets.
New Home Sales also dipped by 8.7% from July to August, albeit remaining higher than the previous year. The demand for new construction homes persists due to the scarcity of existing homes for sale. However, there's a pressing need for a more abundant supply of new homes to meet this demand. Despite a decrease in the median sales price for new homes, this metric can be influenced by the composition of lower-priced and higher-priced homes within sales data.
The current economic landscape reflects mixed trends in inflation, showing some signs of improvement. Meanwhile, the housing market grapples with sales and supply challenges, leading to a decline in transaction volume. The central question that looms is: Where will the much-needed increase in inventory originate from?
The Housing Market Stagnation
Pending home sales in the United States have reached their lowest point since April 2020, primarily due to the combined impact of rising interest rates and soaring home prices. The Federal Reserve's intention to reduce demand has been realized, albeit with an unforeseen consequence – a significant drop in affordability. Currently, the average American family must allocate approximately 44% of their income to afford a mortgage payment. Since most homebuyers finance their purchases with minimal down payments, there's limited room for payment relief without substantial seller concessions. The chart below illustrates a striking 40% increase in home prices over the past three years. Unless there's a surplus of housing inventory and strong demand, this trend is unlikely to reverse. Even in the event of an official recession, improved mortgage rates could lead to increased demand, and numerous approved buyers are patiently waiting for an opportunity. While inventory may expand, it's expected that demand will continue to outstrip supply
The most significant component driving the Consumer Price Index (CPI) is housing costs, primarily shelter expenses. Rent costs are anticipated to decrease further as U.S. rents have fallen by 1.2% compared to the same period last year, representing the most substantial year-over-year decline since December 2020.
The Federal Reserve is awaiting tangible signs such as a lower CPI and an increase in unemployment to consider altering its current trajectory of rate hikes for the year. The longer it takes to rein in inflation, the more time it will take for prospective homebuyers to experience the much-needed relief in terms of affordability. Unfortunately, there's an expectation of slight improvement in unemployment figures tomorrow.
Affordability concerns are not a recent development. While lower interest rates make mortgage payments more manageable, the competition in the housing market has intensified significantly. Many potential homebuyers are waiting for rates to decrease, while others are fatigued from competing with numerous other buyers. The paradoxical news is that rates are likely to improve, but competition will remain fierce, and home prices are expected to continue their upward trajectory. While homeownership remains a secure long-term investment, it is rapidly evolving into a luxury for many.
DOES IT MAKE SENSE TO BUY NOW?
In every market, and for each individual, the answer varies. Schedule a meeting with me to assess the cost of delaying your decision in your specific market. We'll consider factors like inflation and tailor our analysis to homes within your price range. Additionally, we can evaluate the expenses associated with waiting, such as comparing renting costs to buying, even with slightly higher interest rates.
It's important to recognize that real estate remains a secure long-term investment. One of the primary advantages of owning a home is the opportunity to accumulate equity. With each mortgage payment, you chip away at the principal balance of your loan. Furthermore, if your home's value appreciates over time, your equity can grow even more. This equity serves as a valuable asset, accessible through home equity loans or lines of credit or realized when you sell the property.
Homeownership offers a sense of stability and control that renting often lacks. When you own a home, you have greater autonomy to personalize and utilize the space according to your preferences. You don't need to worry about landlords increasing rent or imposing restrictions on your living arrangements. Additionally, owning a home fosters a sense of community and belonging, as you become an integral part of a neighborhood and can establish enduring relationships with neighbors.
It's essential to understand that the current interest rate environment is temporary, whereas the scarcity that makes real estate a sound investment is not. Homeownership is becoming a luxury, and there's no immediate solution to housing affordability. Inventory cannot magically increase to drive prices down. I encourage you to do the math, and if it aligns with your financial goals, consider taking the leap into homeownership.
