The House Party may be Over PulteGroup, Inc. (NYSE:PHM), Toll Brothers Inc (NYSE:TOL), KB Home (NYSE:KBH)

The focus has been less on housing but more on inflation data in FOMC circles recently, but today we received very weak pending home sales data that puts housing front and center again.  Housing was humming along, so to speak, with interest rates still low and mortgage rates still low, but in August something very interesting happened.

Pending home sales fell by 2.5% in August, suggesting that potential buyers were apprehensive.  What might make buyers apprehensive in a housing market that has been driven by extremely low mortgage rates?  We could easily point the finger to the risk of higher rates, but that usually has a spurring influence on the purchasing decision, so we need to look at that in another way.

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Interestingly, in the face of an FOMC meeting that actually had a high probability of resulting in higher rates, mortgage rates fell.  Even after the decision, and as the chance of a December hike increases beyond 60%, mortgage rates are falling. 

What would make mortgage rates fall in the face of potentially higher rates?

The answer is demand.  If demand levels are weak mortgage companies will offer better rates, so the weak demand numbers we have seen today from August seem to be the reason rates have fallen ahead of and after an FOMC meeting and during FOMC speeches that centralized around prospects for rate hikes.

Because potential rate hikes usually spur buyers to lock in lower rates, and this time that did not happen, something else must be at play.  It is very possible that the value proposition has diminished significantly for prospective buyers, and although individual buyers looking for a home may still find it difficult to find something good, real estate investors appear to be seeing the inverse relationship between price and interest rates as a put to their decision making process.

Real Estate investors who have identified the risk of higher rates must calculate their ability to resell properties at higher rates and therefore include a declining affordability factor in their business plan, which typically reduces margins.  Where novice homebuyers tend to think that buying at ultra low rates is good, investors know that prices fall when rates go up, and if rates are about to start to increase that makes real estate a bad investment, and investors begin to anticipate price declines, or deflationary pressure from the housing market.

The weak pending home sales data appears to be telling us exactly that, and because housing is so important to the inflation picture the FOMC is watching, it is much more important than oil by the way, if the data received today is followed by more housing related concerns it will put the FOMC back on pause.  Today's housing data is telling the FOMC that pricing pressure will come if they raise rates, and that will dampen inflation hopes even after OPEC, and the FOMC does not want deflationary pressures and certainly does not want to cause them. 

Monitor these housing stocks:

  • PulteGroup, Inc. (NYSE:PHM)
  • Toll Brothers Inc (NYSE:TOL)
  • KB Home (NYSE:KBH)

 

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