Equities continue to suffer with the moves yesterday wiping out year-to-date gains in most indices. The risk-off move benefitted Treasuries with the 10-year note rallying down to 3.03%, a level last visited on September 26th. The move wasn’t larger in Treasuries, however, given strong resistance at these levels, Fed Chair Powell, FOMC minutes and supply all coming next week. Worries over peak earnings, looming China trade wars, Brexit uncertainty, and swooning oil prices all worked to keep the selling pressure in stocks intact. Meanwhile, other tangible reports point to more slowing in the housing market with October housing starts off in the single-family category for the third month in the last five. Later this morning we’ll get October existing home sales (90% of the market) with a small 1.0% increase to 5.20 million units sold after a three-year low of 5.15 million in September. We discuss in more detail below the faltering housing market, the expectations for the sector in 2019, and the implications for the economy at large.
|Economic News||Despite Drop in Oil Gas Prices Remain Elevated||Agency Indications|
We probably don’t have to tell you that equity markets have been in a world of hurt this month with most indices giving up all their year-to-date gains. There are plenty of reasons to ascribe to the selling and the risk-off tone from peak earnings, global economic slowing, increasing Chinese trade tensions, and, of course, higher interest rates courtesy of the Fed. Another source of some of the market angst can be found in the increasingly problematic housing market indicators.
This week started off with a dismal read from the National Association of Home Builders reflecting decreasing confidence on the part of builders. That was followed by a seemingly decent housing starts number for October but it was goosed by higher than expected multi-family starts. The more important single-family starts number was down on the month making it three out of the last five months in negative territory. Permits also didn’t signal a real upswing for future starts.
Bloomberg Economics is calling for more dramatic slowing in the coming months but that slowing will sow the seeds for a rebound in late 2019, per their analysis. They project that home price appreciation will slow to 1%-2% by the end of next year from the current pace of 5.5+%. That slowdown in price appreciation will allow wage gains at 3%-4% to put more consumers in the hunt for homes. Bloomberg is expecting the pace of sales to slow to 4.8-4.9 million by early next year from the current 5.15-5.20 million. They then expect, with the aforementioned wage growth, that sales will return to the current levels by this time next year.
One saving grace for this slowdown is that the current sales pace never approached the heady levels pre-crisis so the expected slowing won’t be as dramatic, thereby cushioning some of the negative economic impact. Also, credit quality metrics all appear much stronger than pre-crisis indicators such that delinquencies and defaults should not be near the disaster they were ten years ago. Adding to woes for the sector, the recent Federal Reserve Senior Loan Officer Survey noted lending standards were generally kept stable to slightly looser in the third quarter but officers noted decreasing demand across almost all categories of loans, including residential real estate, even with the slightly looser underwriting standards.
We’ve been noting in this space for quite some time the disparity between annual home price appreciation in the 5.8%-6.5% level versus average annual wage gains of 2.5%-2.8%, and real wage gains—net of inflation— at 0.7%. We’ve noted that this disparity would have to be resolved in either slowing home price appreciation and/or greater wage growth. The wage growth component hasn’t moved much until very lately but home price appreciation, as measured by the S&P CoreLogic CS Home Price Index, peaked at 6.5% in March and was most recently 5.8% in August. In addition, unit sales have slowed given the reduced affordability with annualized unit sales peaking at 5.6 million March versus 5.15 million in September.
And we’ve saved the best for last in factors affecting both the level of sales and price appreciation and that is the increase in interest rates. Over the past year the average 30-year mortgage rate has increased over 100bps and the combination of higher rates and prices have worked to cut affordability slowing both sales activity and price appreciation. Bloomberg predicts that the slowing in sales will temper price appreciation in 2019 allowing for wage gains to increase improving housing affordability which will, in turn, increase sales and price appreciation.
Of course this relatively optimistic rebound scenario implies that the other headwinds bedeviling the market don’t reach a crescendo that imperils the expansion. The Fed has penciled in 2019 GDP growth of 2.5% so there is room to weather more economic turbulence but as the risk markets have shown since early September confidence can be a fickle and fleeting thing. That’s something the Fed, hopefully, takes note of when they meet in December.
Despite Drop in Oil Gas Prices Remain Elevated
With the holiday season now upon us, the highest Thanksgiving gasoline prices in four years probably won’t deter Americans from hitting the road for the family feast, nor for the Christmas holiday period next month. Automobile traffic is expected to climb nearly 5% over the holiday period, defined as November 21-25, with 48.5 million people planning an excursion, according to AAA. What’s interesting to note in the graph is the relative stability of gas prices around the Thanksgiving period going back to 2014. But given the 30% drop in oil since October 3rd, one would expect more than the 7% decline in pump prices during the same time frame.
Agency Indications — FNMA / FHLMC Callable Rates