Economic growth likely translates to expanding credit availability, better employment data and greater demand from first-time homebuyers and young adults.
The Fed is likely to start hiking rates sometime this year – most market watchers are in agreement on that. But there is less agreement on what a less accommodative Fed means for housing.
Some point to the taper tantrum of 2013 and infer that Fed rate hikes will translate into a further slowdown in housing, but we think this is a misconception. As a reminder, mortgage rates increased by over 100 basis points during the taper tantrum and materially slowed momentum in U.S. housing. We believe the housing market will be far less impacted this time around for three key reasons:
- Fed motivation. The Fed has made it clear that it will not raise rates unless economic data and financial conditions warrant such an action. Economic growth likely translates to expanding credit availability, better employment data and greater demand from first-time homebuyers and young adults.
- Fixed rates. In the U.S., monetary policy alone tends to have a limited impact on mortgages because most mortgage loans are fixed. Fed policy affects short-term interest rates, but most U.S. mortgage rates are fixed and more levered to the intermediate (five- to 10-year) portion of the yield curve. (Outside the U.S., however, mortgages are largely floating – this means the borrower, not the originator or investor, bears the interest rate risk.
- Purchasing power. Even if Fed rate hikes translate to higher interest rates further out on the yield curve, a 100 basis point rise in the mortgage rate from 4% to 5% will raise the monthly payment by $112 on the median priced home in the U.S. Although that is a meaningful amount of money, we believe that most prospective homebuyers would either pay the additional interest or simply look to purchase a home that cost $112 less per month, rather than decide not to purchase at all. For many, the rise in mortgage rates will likely have no impact as unemployed Americans, or those without the financial resources to consider purchasing a home, are unlikely to engage in homeownership regardless of the level of interest rates.
Bottom line: Fed rate hikes likely will not translate to downward pressure on housing and PIMCO expects interest rates to remain relatively low given high levels of global debt, benign inflation and an aging population. If anything, because we expect the Fed to move when it believes economic conditions warrant less accommodation, we can also expect to see greater demand for housing from a larger labor force that is benefitting from gradual wage growth in a strengthening economy. To that end, it’s possible that modestly higher mortgage rates could actually coincide with greater momentum in housing.
The last hiking cycle resulted in the Federal Reserve raising the fed funds rate by 400 basis points (bps), yet mortgage rates only moved 40 bps. While the trough-to-peak in mortgage rates was 120 basis points during that cycle, mortgage rates spent the better part the two-year hiking cycle in a very narrow range.