Housing sector stocks have been among the worst performers in 2018, and analysts are pointing to lots of different reasons including the newly imposed U.S. tariffs on Canadian softwood lumber. But an easier explanation arises when we look at interest rates.
Mortgage rates are not yet empirically “high”. I bought my first house with a 13% mortgage, so rates that start with the number 4 still seem pretty low, at least to me and my ge-ge-generation. The key insight contained in this week’s chart is that mortgage rates are high compared to 30-year T-Bond rates. Both rates have been rising in 2018, and the 30-year mortgage rate has been more than a full percentage point above the 30-year T-Bond yield for most of 2018.
Most of us remember the “Housing Bubble” of the early 2000s, and we remember that the housing sector started getting into trouble beginning in 2005. That was when this spread between mortgage rates and T-Bond yields first rose above 1 percentage point. That seems to be the magic threshold. Keeping the spread under 1 point is stimulative to the housing prospects. Seeing it go over 1 point is when the pain comes.
To see that point more specifically, here is that same spread between mortgage rates and 30-year Treasury yields, compared to the HGX Index:
This allows us to see that in both 2005 and 2018, the point when the spread went above 1 percentage point was the moment when the trouble started for the HGX. And the decline in the housing sector ended in 2009 once the spread finally dropped back below 1 point.
So why is this spread up above 1 point now? One partial answer is that a former buyer and holder of mortgage-backed securities (MBS) has now turned into a seller. The Federal Reserve started buying MBS notes in addition to T-Bonds and T-Notes as part of its quantitative easing (QE) programs. Now the Fed is paring its holdings, and has turned into a net seller of MBS. So the rest of the bond market has to take up that supply, and it is currently demanding a premium of greater than 1 point over Treasuries.
If the Fed panics and restarts QE in 2019, or if they even just halt the $50 billion per month rate of sales of Treasuries and MBS, then the housing sector could finally see some relief and start to find its footing again.