Aug 9 2006 9:02AM | Permalink | Email this | Comments (0) |
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New home sales will get a small boost from the fed’s decision to keep the federal funds rate target at 5.25% and wait and see if further credit tightening is necessary. 10-year T bill rates, the reference rate for 30-year fixed rate mortgages, quickly retreated to 4.91% and may fall a few more basis points later in August. The 10-year rate had reached 5.25% late in June when a 0.25% August 8th rate increase had been expected. 30-year fixed mortgage rates have retreated in parallel from 6.8% to near 6.6% with a further small decline likely in the second week of August.

The housing boost will be small because higher mortgage rates were only one of several reasons for the decline in new home sales. Other reasons include slower job and income growth as the economic expansion matures and a sharp reduction in home price appreciation amidst a surge of “for sale” signs on front yards. Also, there are fewer households buying homes sooner than they had planned to take advantage of cheap credit as well as tighter credit standards as mortgage delinquencies begin to rise on loans with initial low rates.

The boost to the residential construction market from lower mortgage rates will be most noticeable for single family homes in cities that experienced little speculative buying in 2004-05 and hence no flight of speculation in 2006. The boost is likely to be too small to measure in the overbuilt and overpriced condo markets in the southeast and southwest.

If you were surprised by the fed’s decision, remember that the fed is searching for the interest rate appropriate for the demand and inflation conditions expected 3-6 months ahead not three months ago — the period for which the latest data reports cover. That means that they interpret the recent higher than expected inflation not as evidence of an overly exuberant economy as in 1999 but as a precursor to slower demand growth and hence reduced inflation pressures during the coming winter. The fed sees the 2006 rise in inflation not as excessive demand (that was last year) but as random supply shocks that must be presumed to fade away rather than persist.

There is still a risk that credit costs could be raised 0.25% late in September. That risk is bigger if there are more supply shocks from repairs to the Alaska pipeline, hurricanes or the Israeli invasion of Lebanon. The risk is also bigger if the demand growth trend rises above the spring 2.5% pace. Labor and retail markets will give the first signs if this occurs.