As housing goes, so goes the economy. Today, this is as true as ever. The Fed hit a pause button on tapering after mortgage rates rose sharply, and it awaits more evidence of sustained progress. While some housing indicators softened in recent months, we remain optimistic on demand. We explain why below.
■ The missing link in housing ... until now.
Turn back the clock 12 or 24 months, and almost all of the factors needed to support housing demand were in place. Affordability? Check. Demographics? Check. Steadily improving income prospects? Check. But no one wants to buy a depreciating asset and would-be buyers were perfectly happy renting instead. Now that prices are posting double-digit increases, perceptions about owning may be changing.
■ Expectations are finally heading north.
Our models confirm that price expectations are a fundamental driver of housing demand, and homebuyers simply extrapolate from recent performance. We found that price expectations can be approximated by a simple six-quarter moving average of realized gains, lagged by one quarter. Measured this way, expectations crossed over to positive territory earlier this year, and are now approaching 5%.
■ Real mortgage rates are heading south.
Mortgage rates rose sharply during the summer months, but price expectations rose even faster! Our real mortgage rate proxy is now turning negative, and is projected to decline to -4.7% by mid-2014.
■ Nominal rates - how high is too high?
Our scenario assumes that the 10yr Treasury yield rises to 3.75% by the end of 2014 and to 5% by 2017. This is not enough to derail housing demand, provided that price perceptions evolve in line with our expectations. Our models predict a further 11% increase in existing home sales over the next two years, and a further 45% increase in new home sales over the next three years, with the former peaking in 2016 and the latter in 2017.
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