Mortgage Rates Continue to Jump

U.S. weekly averages as of February 17, 2022

Mortgage rates jumped again due to high inflation and stronger than expected consumer spending. The 30-year fixed-rate mortgage is nearing four percent, reaching highs we have not seen since May 2019. As rates and house prices rise, affordability has become a substantial hurdle for potential homebuyers, especially as inflation threatens to place a strain on consumer budgets.

Week of February 14, 2022 in Review

News on housing, inflation and the minutes from the Fed’s latest meeting all made headlines, while investors were also closely watching the news surrounding Russia and Ukraine.

 Sales of existing homes were up 6.7% in January, coming in much stronger than estimates of a 4% drop and reflecting the big demand for homes that remains around the country. But the real story was the inventory shortage. There were only 860,000 homes for sale at the end of January, which is another record low and down from December’s reading of 910,000. Inventory was 16.5% lower than January 2021 and a completely different picture compared to the bubble-like conditions we saw in 2007 when there were 3.7 million homes for sale.

The high demand for homes has also kept builders confident even in the face of higher building material costs and the lack of skilled labor. Though builder confidence fell 1 point to 82 in February per the National Association of Home Builders Housing Market Index, any reading over 50 on this index (which runs from 0 to 100) signals expansion. So, confidence remains at a strong level despite the slight decline.

Meanwhile, Housing Starts, which measure the start of construction on homes, fell by 4.1% in January. Starts for single-family homes also declined. On the positive front, Building Permits, which are a good forward-looking indicator for Housing Starts, increased. However, one of the main takeaways is that the backlog of homes continues to grow. Homes authorized but not yet started were up 37.3% year over year.

Rental prices were also on the rise, as CoreLogic’s Single-family Rent Report showed they increased 12% year over year in December – the fastest increase in over 16 years. Note that this report measures both new and renewal rents for both single-family homes and condos, putting it slightly lower than recent data from Apartment List. Their rent report, which looks primarily at new rents, showed nearly 18% annual growth in January. To put this in context, annual rent growth averaged just 2.3% in the pre-pandemic years from 2017-2019.

Wholesale inflation remains red hot, with the Producer Price Index coming in double market expectations at a 1% rise in January. On a year over year basis, the index was at 9.7%, which is just off December’s record high since the methodology for collecting data was changed in 2010. Core PPI, which strips out volatile food and energy prices, rose 0.8% in January, while the year over year figure remained at a record 8.3%.

Rising inflation is critical to monitor because it can have a big impact on Mortgage Bonds and home loan rates. Investors were highly anticipating Wednesday’s release of the minutes from the Fed’s January meeting, to learn more about how the Fed plans to address inflation. Read more about this below.

Investors were also closely watching the events regarding Russia and Ukraine. Bonds can act as a safe haven when the economy is doing poorly or in periods of time where there is geopolitical risk, like war or terrorism. This can cause riskier assets like Stocks to sell off, with that money flowing into the safer Bond Market, causing Bond prices to move higher and their corresponding yields lower. We have seen some of this dynamic of late, and it’s something to continue to monitor as events unfold.

Lastly, Wednesday’s 20-year Bond auction was met with just above average demand. The bid to cover of 2.44 was above the one-year average of 2.38. Direct and indirect bidders took 83.9% of the auction compared to 79.9% in the previous 12.

Existing Home Sales Much Stronger Than Expected

Existing Home Sales, which measure closings on existing homes, showed that sales were up 6.7% in January at an annualized pace of 6.5 million units. This was much stronger than estimates of a 4% drop. On a year over year basis, sales are down 2.3%, which is quite miraculous considering higher rates, higher home prices, and no inventory.

And speaking of inventory, there were only 860,000 homes for sale at the end of January, which is another record low and down from December’s reading of 910,000. Inventory is 16.5% lower than last year and a completely different picture compared to the bubble-like conditions we saw in 2007 when there were 3.7 million homes for sale.

There was only a 1.6 months’ supply of homes available for sale at the end of January, Six months is considered a more balanced market, so the current low inventory levels speak to the imbalance of supply and demand. Homes were only on the market for 19 days in January, which should continue to be supportive of home prices.

The median home price was reported at $350,300, which is up 15.4% year over year. Remember that the median home price is not the same as appreciation. It simply means half the homes sold were above that price and half were below it. This figure continues to be skewed by the mix of sales, as sales on the lower end are down sharply, while sales above $500,000 are much higher.

First-time homebuyers accounted for 27% of sales, which is down from 30% in December. Cash buyers rose sharply from 23% to 27%, while investors purchased 22% of homes, up from 17%. Foreclosures and short sales accounted for less than 1% of all transactions.

Construction Backlog Remains

Housing Starts, which measure the start of construction on homes, fell by 4.1% in January to an annualized rate of 1.638 million homes. However, Starts were up 0.8% when compared to January 2021.

Starts for single-family homes, which are the most important because they are in such high demand among buyers, fell by 5.6% from December to January. They were also 2.4% lower on an annual basis.

Building Permits, which are a good forward-looking indicator for Housing Starts, rose by 0.7% in January and they were up 0.8% year over year. Single-family permits also rose 6.8% in January, but they were still down 5% year over year.

One of the main takeaways is that the backlog of homes continues to grow. Completions fell by 5.2% in January and they were down 6.2% from the same time last year, speaking to the challenges builders are having with materials and labor. 

In addition, homes authorized but not yet started increased by 4.9% in January and they were up 37.3% year over year. Single-family homes authorized but not yet started are up 32.5% year over year.

Builders will continue to try and put more inventory on the market, but they are significantly lagging demand, especially on the single-family home front. This ongoing imbalance in supply and demand should continue to be supportive of home prices.

Builders Remain Confident Despite Rising Costs and Labor Shortages

The National Association of Home Builders Housing Market Index, which is a real-time read on builder confidence, fell 1 point to 82 in February. However, any reading over 50 on this index, which runs from 0 to 100, signals expansion, so confidence remains at a strong level despite the decline.

For perspective, this index was at 80 last October, 83 in November and reached an all-time high of 90 in November 2020.

Looking at the components of the index, current sales conditions rose 1 point to 90, sales expectations for the next six months fell 2 points to 80, and buyer traffic also dropped 4 points to 65.

NAHB’s chief economist, Robert Dietz, said, “Residential construction costs are up 21% on a year-over-year basis, and these higher development costs have hit first-time buyers particularly hard.”

The bottom line is that the high demand for homes has kept builders confident even in the face of higher building material costs and the lack of skilled labor.

Wholesale Inflation Continues to Set Record Highs

The Producer Price Index, which measures inflation on the wholesale level, came in double market expectations, rising 1% in January. On a year over year basis, the index decreased from December’s revised higher reading of 9.8% to 9.7%. This is just off December’s record high since the methodology for collecting data was changed in 2010.

Core PPI, which strips out volatile food and energy prices, rose 0.8% in January, coming in hotter than expectations of 0.5%. The year over year figure remained at a record 8.3%.

Producer inflation remains elevated, which often leads to hotter consumer inflation levels, as producers pass those higher costs along to consumers.

Remember, inflation is the arch enemy of fixed investments like Mortgage Bonds because it erodes the buying power of a Bond’s fixed rate of return. If inflation is rising, investors demand a rate of return to combat the faster pace of erosion due to inflation, causing interest rates to rise.

This is why keeping an eye on inflation, and what the Fed may do in the coming months to bring inflation in check, remains critical.

No Real Surprises in Fed Minutes

The minutes from the Fed’s January meeting showed that the Fed is prepared to raise their Fed Funds Rate and shrink their balance sheet soon.

Note that the Fed has two levers they can pull for tightening the economy – hiking their benchmark Fed Funds Rate and reducing their balance sheet. The Fed Funds Rate is the interest rate for overnight borrowing for banks and it is not the same as mortgage rates.

Hiking the Fed Funds Rate will actually be a good thing for mortgage rates, as the Fed curbs inflation and preserves the fixed return a longer data Bond provides. However, reducing their balance sheet (which means allowing Bonds to fall off their balance sheet and no longer reinvesting in them each month) would cause more supply on the market that has to be absorbed. This can cause mortgage rates to move higher.

The minutes strongly indicate that a hike to the Fed Funds Rate is on the way as soon as March. Officials have acknowledged inflation readings showing prices rising at the fastest pace in 40 years and that policy will need to be tighter to bring prices down.

Mortgage Bonds dipped sharply on Wednesday in anticipation of the minute’s release. Fortunately, the minutes didn’t contain any surprises and the market rallied afterwards as a result.

Labor Market Remains Tight

The number of people filing for unemployment benefits for the first time increased by 23,000 in the latest week, as Initial Jobless Claims were reported at 248,000.

Continuing Claims, which measure people who continue to receive benefits after their initial claim is filed, decreased 26,000 to 1.59 million.

There are now 2.063 million people in total receiving benefits, which is a decrease from 2.099 million in the prior week and a stark contrast to the nearly 19 million people receiving benefits in the comparable week the previous year. Claims are at very strong pre-pandemic levels, showing that the labor market remains tight.

What to Look for This Week

After the market closures Monday for the Presidents Day holiday, Tuesday brings home price appreciation figures for December from the Case-Shiller Home Price Index and the Federal Housing Finance Agency (FHFA) House Price Index.

More housing news follows Thursday when January’s New Home Sales are reported, along with the latest Jobless Claims data and the second reading on fourth quarter GDP.

Crucial inflation data for January will be reported on Friday via Personal Consumption Expenditures, which is the Fed’s favored measure, as well as Personal Income and Spending. Pending Home Sales for January will also be released.

Technical Picture

Mortgage Bonds continue to trade in a wide range between support at 99.984 and overhead resistance at 100.617. The 10-year is down to 1.92% and has room to continue lower until reaching 1.88