US housing market should cool, due to spiking mortgage rates, but a 2008 type collapse is unlikely. The mortgage market has remained resolutely fixed rate during the current bull market, which underpins our sanguine outlook. Yes, there are signs of excess, but there’s no risk of monthly payment ballooning considering that variable rate funding is minimal. Prices should soften as financing conditions have tightened rapidly, but a collapse is a low probability outcome.
In broader macro, there is more evidence of slowing US growth and we evaluate how that could adversely impact our bullish natural resource view. With natural resource prices still elevated (both commodities & equities) and positioning surveys also bullish, near-term weakness is possible. However, the longer-term structural supply-constrained bullish view remains in play as index weight remains near 50-year lows.
Dispatch #10 on April 15th, 2022, has the following lineup of stories:
- US property: Gradual slowing is the highest probability
- Inflation close to peaking but a reversal to Fed target is unlikely
- Slowing growth & natural resource allocation
- NFT backed loan
US housing should cool
Residential real estate is the world’s largest asset class, and in the world of interconnected markets, US residential housing has a large impact. Dispatch #7-2022 laid out our “wealth effect” thesis in more detail. Here, we’ll evaluate the prospects of a US residential real estate market that rose 18.8% (Case Shiller index) in 2021. Many assets boomed post-Covid.
- The value of US housing rose by $6.9tn in 2021, according to Zillow
- The S&P500 increase value by nearly $9tn in 2021 says this WSJ story
- Crypto assets rose $1.5tn in 2021, according to the above WSJ article
There are reasonable concerns that US housing faces a 2007-like peak and collapse. However, we see a low probability of a mid-2000s style collapse and see a gradual slowing of the market as the most likely outcome. We lay out our thesis below and rely on the August 2021 Urban Institute Report to shed light on both the similarities and differences of today’s US housing market to the one in 2007.
Mortgages have remains almost exclusively fixed rate
We expect a modest downturn because the mortgage market has remained almost exclusively fixed rates. This means we are unlikely to see sharp payment increases for existing mortgages due to tease rates and other “innovations” of the 2000s. The chart below provides a visualization of the fixed rate vs adjustable-rate mortgage origination going back to 2000.
Mortgage origination composition
In the mid-2000s, the share of variable rate mortgages got as high as 50%.
This happened as private lender gained market share from the quasi-federal entities like Fannie Mae and Freddie Mac. We have been spared that “innovation” during the current boom with agency share staying above the mid-90s.
Nor has there been a spike in variable rate home equity lines of credit that have continued to decline since the 2008/09 peak. Yes, there has been cash-out refinancing (details further below), but mostly via fixed rate first-lien mortgages.
Source: St Louis Federal Reserve
Mortgage rates have spiked sharply
That’s the good news. The bad news is that funding a house has become much more expensive fast. The 30-year fixed rate mortgage rate has risen 50% YTD, and 80% from the low ~ 18 months ago. The entire Covid related low-rate period has been erased and the present rate is nearly at a decade high. The rate of change matters as much as the absolute level. We’d be surprised if both activity and prices do not cool in the coming months as real incomes have not kept pace with higher financing costs. This WSJ article estimates that monthly payment for a buyer of a median home in the US would have to pay ~38% more today ($1700) than 12 months ago.
Mortgage rates have risen primarily because government bond rates have increased. Here’s a chart of the benchmark 10-year Treasury yield going back 10 years.
A secondary factor is the rise in the spread between the 30-year fixed mortgage rates and 10-year Treasury yield. One shouldn’t bet on this spread easing as the Fed is getting ready to reduce the size of mortgage-backed securities portfolio acquired during QE operations. The Fed currently holds MBSs worth $2.7tn.
As rates have rallied, refinancing applications have rolled over.
Purchase applications haven’t fallen to the same extent, but we would expect these to reduce further in the coming months.
The chart below makes the case that owning is expensive vs. renting. Without knowing the details of the assumptions, it is best to absorb the directionality rather than the absolute levels.
There are also some signs of excess
Homeowners have taken out a decent amount of equity in the past few years as cash-out refinancing has surged. That’s no surprise as the majority of mortgage originations since 2019 have been refinancings.
The cash-out chart the right shows data to 1Q2021. The chart below shows that cash-out refinancings increased in value into 2H2021 and rose sharply as a share of refinancings. We should anticipate that a cooling housing market will have an impact on consumption too.
Mortgage Originations by Purpose
Source: Black Knight Originations Market Monitor December 2021
Underwriting standards, while more robust that the mid-2000s, also eased.
Did you know there was something call “automated appraisals” or an “appraisal waiver”, which only ended when the Fed recently raised rates?
However, the post-Covid mortgage origination surge has skewed to higher credit score applicants.
Average Credit Scores
Source: Black Knight Originations Market Monitor December 2021
The research presented above translates into a base case of a gradually cooling housing market in the coming months. This likely includes some sequential price declines and YoY declines later in the year and into 2023. This is not an outlier view. Even the Mortgage Bankers Association expects loan origination volume to drop ~36% in 2022.
Inflation is close to a peak, but unlikely to reverse to Fed target
March headline inflation hit 8.5%, a four-decade high, but the equity markets reacted positively initially. The source of positivity was core inflation only rising 0.3% MoM. While we believe that headline inflation is near a peak, we don’t see it reversing anywhere near the Fed’s 2.7% (core PCE) 2022 target.
One of the key areas to lower inflation will be used car prices. The index is just starting to rollover. Unlikely the previous pauses during the post-Covid price spike, we now face slowing economic activity as inflation crimps consumer budgets and financing costs jump. In March used car prices were -3.3% MoM but still +24.8% YoY. In addition, US Trucking price & volume decline (next story) illustrates that there’s likely a broad slowing in the goods sector.
However, we expect several offsets to weaker goods prices.
- Shelter cost that has not increased to reflect surging home values. March shelter costs rose just 5.0% YoY. Recall home prices rose 18.8% YoY in 2021.
- Rising service costs. Delta Airlines CEO said this week that demand continues to surge and they continue to raise prices. This comment provides a peek into service prices as consumers emerging from a two-year lockdown.
- March PPI index rising 11.2% YoY shows that there’s still plenty of inflation still coming through supply chains. China lockdowns are likely to further buffet supply chains in the coming months.
Slowing growth and commodity allocation
Regular readers know our skew towards real assets and natural resources. This section attempts to evaluate that preference as evidence of slower growth increases. Historically, natural resource prices and stocks have done poorly during recessions. However, we are aware that we might be facing a stagflationary outlook — something we’ve not encountered for half a century!
Last week, Dispatch #9 discussed slowing container shipping rates. The chart below shows slowing US trucking SPOT prices and volumes, which is a robust data point that indicates slowing economic activity. The chart below shows spot prices (white line) slowing sharply.
The bulk of truck volumes is based on contract prices that will eventually follow the direction of spot. Volumes, too, have declined as this Freightwaves chart shows (blue line is current series).
Intermodel rail volumes have been more stable, and rail remains more cost-competitive against trucking. This Tweet thread provides an industry-insiders take on the ongoing slowdown in US freight markets.
In addition to US data, we note the tight correlation between Chinese imports and global commodity prices. Is this time difference due to multiple supply shocks or are we just about to see commodity prices catch up with the decline in Chinese imports?
Positioning is skewed
With the above-mentioned evidence of slowing activity, it’s unnerving to see overweight commodities positioning from BofA’s Fund Manager Survey. The combination of further evidence of slowing, the correlation between China and commodities, and positioning points to elevated short-term risks for natural resources.
However, the long-term positioning picture is decidedly favorable to natural resources. Weights of energy and materials within the S&P 500 are near 50-year lows. Furthermore, if we face a stagflationary outlook, the correlation between growth slowing and natural resource assets could be different. We typically dislike the “this time is different” explanation.
And that is backed up by the performance of energy and materials over the past decade.
Where does that leave us? In the short term, markets could be negatively surprised by the growth slowdown as positioning is heavy and many commodity prices are near highs. However, that’s likely to present an attractive entry point from a longer-term perspective. The structural supply shortage for many commodities has only worsened since the Ukraine invasion. While we may adjust exposure tactically, the data does not change our longer-term conviction in real assets and natural resources.
$8.3m loan backed by CryptoPunk NFTs
If you think NFTs of the JPEG variety have no value, this is a data point that may require a re-think of that view. A holder of 104 CryptoPunks that was to be auctioned on Sotheby’s withdrew the Punks and took out the loan. This Decrypt article has details about the transaction made via decentralized loan market place NFTfi. This is another data point for the hardening monetary property of blue chip NFTs like CryptoPunks. However, this is a transaction within the very small NFT community, and we shouldn’t over-extrapolate this transaction’s impact on monetary hardening.
If you made it all the way down here, thank you! The Dispatch will be on the road in the coming ten days and may not publish the following two weeks. Stay safe and do reach out if you have any questions or comments about the material in this Dispatch.
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