Are Mortgage Rates the Real Issue?

Housing activity has slowed noticeably over the past couple months. Sales of new and existing homes have stagnated, while new residential construction has been volatile. Most market watchers say higher mortgage rates are to blame.

To be sure, higher mortgage rates raise the monthly cost of financing and owning a home, but rising home prices are also a contributing factor to overall costs.

On the latter, most data sources point to a sustained rise in home prices. The latest data release from S&P/Case-Shiller confirms the trend. Case-Shiller's home price index show that prices rose in 18 of the 20 cities it follows ( Minneapolis and Cleveland were slight laggards). Overall, home prices rose 1% in May compared to April. This latest increase lifts the year-over-year gain to 12.1%.

The laws of supply and demand state that when prices rise demand falls. But at the same time, rising prices draw more supply into the market. As we know, lack of supply has restrained sales growth over the past year. The good news is that we have seen supply in existing homes for sale increase over the past few months. Rising home prices are, no doubt, a contributing factor.

Going forward we see home-price gains moderating. This should help draw more homes into supply. We say that because more potential sellers will no longer be compelled to wait if they believe the price trend is moderating, or even stagnating. When you become more unsure of the future, you tend to act now; you don't wait.

We view moderating price gains as a positive. Indeed, low single-digit annual price gains would be more indicative of a normalized housing market. Double-digit year-over-year price gains aren't the norm, nor are they sustainable.

We remain somewhat skeptical, though, that recent mortgage-rate increases and tight supply are the main culprits behind the recent slowdown. Economic growth, or rather the lack of growth, could very well be the real culprit.

The fact is that economic growth remains sluggish. In the second-quarter of 2013, gross domestic product (GDP) grew at a 1.7% annualized rate (normal growth is around 3%).

Because the economy isn't quite firing on all cylinders, we doubt that we will see any dramatic moves in mortgage rates.

Job growth will be key. If we see sustained job growth over the next couple months, this will be indicative of stronger economic growth in the third quarter. If that occurs, rates will move higher, but we still don't think they'll move materially higher.

We don't expect to see 5% on the 30-year fixed-rate loan until the Federal Reserve unequivocally indicates it will cut back on quantitative easing, and that remains the great unknown.

Courtesy of Jessica Regan.

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