Housing is not quite as important as the Fed sometimes seem to think, said Ian Shepherdson, Chief Economist at Pantheon Macroeconomics. The Fed seems to be as much obsessed with housing as much the labor market, but it’s not necessary for housing to keep charging upwards for the rest of the economy to grow.
It’s a relatively small share of GDP now in terms of housing construction, even when one adds in the retail stuff that’s related to housing. But it’s important to sentiment as everybody seems to be obsessed with house prices. The rebound in house values has drastically improved the personal sector’s balance sheet. The Fed is certainly very concerned about it in a way perhaps two or three months ago they weren’t; they were ready to dismiss it as something temporary. And now their worries are much deeper it seems, he noted.
Asked if housing could roll over as yields and interest rates move up, Ian answered in affirmative. Over the last year, the affordability index has declined sharply, marking the biggest drop in 30 years. If mortgage rates rise further as the rest of the economy picks up, then housing would be under further pressure. It’s kind of a paradox here that the stronger the economy gets, the more the market gets worried about the Fed raising rates, the higher 10-year yields will go and the higher the mortgage rates will go and potentially the weaker the housing market will get, he argued.
Asked if he’s confident Fed Chair Janet Yellen will be able to normalize rates or will be able to do a more restrictive stance two, three and four years out, Ian said that’s really a big issue. The problem is that there’s an awful number of ways the Fed can get it wrong. They can tighten too slowly, they can tighten too quickly, they can start too late, they can start too early or they can mess up the balance sheet. There are million ways they can go wrong and a relatively small number of ways they can get it right.
At the moment it’s kind of uncertain as to which scenario the Fed will follow. What’s going to drive them is the state of the labor market, and hopefully, that will put them on the right track, he observed.
A Goldman Sachs report says markets have it wrong about rates and predicts rates are going to rise in 2016. Investors have crowded into high yield even in 2014 after a couple of amazing years of yields. They are very well invested in parts of the market that do provide a little bit of yield. There’s probably not a tremendous amount of spread tightening in that market. So investors will simply be clipping the coupons for the next couple of years.
Asked if rates are going to stay low in 2016 as the Goldman Sachs report suggests, Ian said rates will probably move as early as the spring of 2015. A combination of rapid decline in unemployment, a bit of a pick in wages and some pick up in some of the components of the core CPI will probably trigger a rate hike.
Unfortunately, housing will be a necessary casualty of this as that’s the way the Fed’s thinking evolves. If the economy strengthens broadly and housing weakens, the Fed will probably learn to live with that, since that’s the price to pay to get the rest of the economy moving.
That’ll make it a very unusual late stage recovery though the events that led the economy to this were quite unusual as well. Housing is likely to lag behind as those events start to unwind, he concluded.
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