What the Housing Doldrums Mean for Fed Policy

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Housing weakness is bucking the trend toward modest growth in the US economy, but a change in Fed policy could coax more homebuyers off the sidelines.

Last week we received more data showing that housing remains in the doldrums. New home sales plunged 14.5% in March, well below consensus expectations. And March existing home sales fell 0.2%. That marks the seventh time in eight months that we’ve seen a contraction in existing home sales. In fact, existing home sales are down 7.5% over the past 12 months—the steepest rate of decline since May 2011.

In addition, data recently released by Inside Mortgage Finance, a mortgage industry newsletter, showed that lenders originated 58% fewer mortgage loans during the first quarter than they did one year ago and 23% fewer than they did in the fourth quarter of 2013. Applications for purchase mortgages last week ran nearly 18% below the level of a year ago, according to the Mortgage Bankers Association.


Signs of a Pickup

The disappointing housing data come in stark contrast to recent reports on other areas of the economy, which have seen significant improvement recently. For example, March durable goods orders rose well above expectations and the previous month’s level of growth. This raises the question, “What will nudge housing forward?”

Two key catalysts could boost momentum. The first reason is continued improvement in the overall economy. The March index of leading economic indicators rose 0.8%, beating expectations, and besting the previous month’s increase, suggesting growth will accelerate in the next few months. Specifically, we likely need to see continued improvement in jobs and consumer sentiment, which are closely linked. Consumer sentiment has also improved substantially, as evidenced by last Friday’s University of Michigan survey.

However, the linchpin is the job market, an area where we’ve seen improvement recently. It would not be surprising to see continued job growth in the upcoming April employment report.

“If housing continues to sputter, then there’s a chance the Fed could revise its tapering strategy.” 

A Taper Tilted to Treasuries?

The other, more immediate catalyst that could lift housing is a possible change in the Fed’s monetary policy. If housing continues to sputter, then there’s a chance the Fed could revise its tapering strategy. While it’s unlikely the Fed would slow its tapering timeline given that, outside of housing, much of the economy is actually accelerating, perhaps it could change the makeup of tapering.

For example, the Fed could focus tapering on Treasuries rather than mortgage-backed securities in an effort to only impact housing by driving down mortgage rates. This is a strategy that Boston Fed President Eric Rosengren (among others) has advocated for some time now. Such a change in monetary policy could have a much larger, more positive impact on the state of the housing market than other factors such as the slight loosening of credit standards that we’ve seen recently.

In fact, the importance of the Fed’s monetary policy is tied directly to a key finding from Allianz Global Investors’ semi-annual global RiskMonitor survey. The poll results, which are being released today, show that institutional investors cite interest-rate risk as one of the “most acute risks in 2014.” On the one hand, institutional investors seem to have “confidence that central banks will restore rates to normal levels gradually, without shocking the equity markets. On the other hand, “investors apparently recognize what is at stake if central banks were to mismanage the raising of interest rates.”

As the Fed slowly eases its accommodation, it’s critical that central bankers manage this process carefully to ensure there are no sudden jolts to the stock market. Plus, Fed officials must provide support to other areas of the economy, particularly housing. Look to the FOMC meeting this coming week for further color on the Fed’s progress.

Kristina Hooper, CFP, CAIA, CIMA, ChFC, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.

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