Now that 2014 is well underway, we have gotten a taste of what life might be like with a less accommodative Fed and what those implications might be going forward on our markets, specifically interest rates and housing.
Does the Fed Taper Equal Weaker Equity Markets?
It seems the Fed is serious about sticking to its guns and moving forward with its plans to taper its quantitative easing program (QE). At the Fed's latest meeting, the Fed announced an additional taper of $10 billion bringing the reduction to $20 billion and the remaining amount of stimulus at $65 billion, down from its original $85 billion. Since the beginning of the year, the major US stock indices are down about 5%, with the Russell 2000 small cap index near correction levels, with a nearly 10% reduction from it's high, reached in late 2013. Are equities responding to a reduction in stimulus or is there genuine concern over weaker economic data in the US and wider global economy? Many pundits are claiming that weakness in emerging market currencies, weaker Chinese PMI equivalent data, and concerns in the Euro zone are causing markets to sell off. However, given the market's recent propensity to brush off all concerns leading in to 2014, it is hard to allow that the recent weakness in markets is due to weak economic data. More likely are the combination of money managers protecting sizable portfolio gains with an eye on a less accommodative Fed and the scary prospect of weakening economic data (January's employment figure was far less then estimated and employment claims have been creeping higher, reversing a downward trend) in the face of a less effective Fed. What are money managers to think if the Fed's tool bag appears spent and is unarmed to defend the economy from, not only weakening data, but a potential black swan shock (could this come from the trillion dollar student loan bubble?) These are legitimate and debatable concerns, and not just academic discussions, as equity markets are, indeed, selling off and displaying weakening technicals (trend lines are falling harder than German troops in a wintry Russian countryside).
Weakening Equites Contributing to Strengthening Bonds Resulting in Lower Yields?
As is often the case, fixed income securities can benefit from a weakening equity market as monies flow from equity portfolios to treasury portfolios in search of security. As treasury prices rise and their associated yields decline, most other fixed income securities follow suit, as their prices and yields are a function of treasuries. The correlation is not 100% but it's a decent rule of thumb. Why do we care? Because mortgage rates are priced off of the 10-year treasury bond, and this directly affects one component of housing affordability. One of the concerns heading in to the new year was the consensus of a rising rate environment in the US and its implications on the housing recovery. The Fed's zero interest rate policy (ZIRP) has remain unchanged and the Fed is steadfast in its resolve that rates will continue to stay low. This is a cornerstone of the Fed's policy of leading the market through use of its forward guidance and less with open market operations, allowing the balance sheet to remain contained. As a result, homeowners and potential homeowners can benefit as a result. In just the past week, average 30-year fixed mortgage rates have come down 10 basis points, or 0.10% (100 basis points equals 1.0%). Changes in rates like this can assist buyers as well as owners looking to refinance existing debt, relieving debt burden. Interest rates are likely to rise one day, to be sure, but equally important is the time frame by which they rise. Consensus opinion is that rising rates would not harm the nascent economic recovery if the rise was slow and consumers could acclimate to the higher cost of credit.
In an earlier post, I did the math for the impact a rise in mortgage rates would have on housing costs. Here is what I found: For a 30-year conforming loan amount of $417,000, the interest and principal payment would rise just over $29 with a rise in the rate by just 0.125% or 1/8 of 1.0%. This does not sound all that impressive or substantial. However, to put this in to context, this rise would result in a loss of purchasing power of just over $6,400. In a declining rate environment, the opposite is true, these payments would fall accordingly and purchasing power would increase. These numbers reflect what occurred over just the last week. If the trend were to continue, housing does become more affordable, as long as prices do not have a corresponding rise. As the rise or fall in rates happens faster than prices move, this is unlikely to be the case, at least initially, particularly in the face of a weakening labor market.
In an earlier post, I did the math for the impact a rise in mortgage rates would have on housing costs. Here is what I found: For a 30-year conforming loan amount of $417,000, the interest and principal payment would rise just over $29 with a rise in the rate by just 0.125% or 1/8 of 1.0%. This does not sound all that impressive or substantial. However, to put this in to context, this rise would result in a loss of purchasing power of just over $6,400. In a declining rate environment, the opposite is true, these payments would fall accordingly and purchasing power would increase. These numbers reflect what occurred over just the last week. If the trend were to continue, housing does become more affordable, as long as prices do not have a corresponding rise. As the rise or fall in rates happens faster than prices move, this is unlikely to be the case, at least initially, particularly in the face of a weakening labor market.
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