Jun 14 2006 11:16AM | Permalink | Email this | Comments (0) |
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Mark June 29th on your calendar for a major announcement on the fate of the housing market this summer.

That’s the day the Federal Reserve Board will announce whether it has or has not raised it’s target for the federal funds rate – and hence all interest rates – another 0.25% to 5.25%. Quotes for interest rate futures were signaling that the fed would not raise rates further in June until the May Consumer Price Index was released on June 14th reporting higher inflation than expected. Expectations changed immediately. 10-year T-Bill rates jumped 0.1% within a few hours, indicating that the financial market now believes that another 0.25% rate increase is far more likely than not. This is the benchmark rate for 30-year fixed rate mortgages.

30-year rates have been essentially unchanged at 6.6% since the fed signaled in early May that it would probably not raise interest rates again at the end of June. This rate will quickly rise to 6.8% if the federal funds target rate is boosted to 5.25%. Indeed, much of this rise will occur before June 29th if the federal funds rate increase is widely expected.

The Reed Construction Data housing forecast is based on 30-year mortgages staying at 6.6%. So are most other housing forecasts. Projected housing starts for the balance of 2006 and for 2007 will have to be reduced if mortgage rates are significantly higher.

Ironically, it was problems measuring changes in the cost of owning a home that caused this very serious threat to the housing market. The Consumer Price Index measures homeownership costs by the change in rents for rental housing. This is a poor measurement approach but nobody has a better idea how to do it. Rents are up sharply due to condo conversions, more jobs and fewer renters buying homes.

This rise in rents was aggravated in March to May by the unfortunately necessary practice of subtracting utility costs from gross rent to get net rent. Plunging natural gas, propane and electricity prices reduced utility costs and thus left net rent higher. It was the 6.8% annualized rise in imputed homeownership cost in May that pushed the core CPI (excluding food and fuel) up 0.3% to 2.4% above a year ago and spurred the inflation fears that prompted lenders to demand higher interest rates.

More reliable inflation measures show less inflation over the last year and less recent acceleration in inflation. The core PPI is up 1.6% and the core PCE (personal consumption expenditure deflator from the GDP accounting system) is up 2.1%. The fed can justify either a 0.25% increase or no change. We’ll have to wait until the 29th to see what happens.