The National Association of Home Builders Housing Market Index (HMI) was reported at 57 this morning-see BLUE LINE in the chart below. This is a sentiment indicator (soft data), but it has been in spite of this a good indicator forecasting home building trends 12mos ahead. Today’s number is quite positive and may even signal an acceleration of the pace in place since late 2011 (SPDR S&P Homebuilders (ETF) (NYSEARCA:XHB)). We should expect to see a good rise in the New Single Family-Starts in the months ahead-see the RED LINE.GrizzlyRock: Long Thesis For This European Travel Company [Q1 Letter]
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Question: Why have higher lending rates spurred higher housing activity?
Answer: The condition of higher-mortgage-rates-while-short-term-bank-borrowing-costs-remain-low provides wider spreads for banks to lend. Banks can take more lending risk and lend to more individuals based on how wide the interest rate spread becomes. The wider the spread the greater the number of individuals who can qualify for mortgages.
It matters more what a bank’s profit spread is than what the actual mortgage rates are! At this point in the business cycle, short term rates remain very low so any rise in mortgage rates result in higher bank profitability. This gives banks the profit to improve their bottom lines even IF the normally anticipated borrower default rate reappears later in the housing cycle as the economy goes through its ebbs and flows.
Simplified Bank Business Cycle:
Banks use shorter term funds to lend longer term and make profits on the spread. This is why profits soar as mortgage rates rise early in the housing cycle as short rates remain low. Later, the end of the housing market occurs as short rates rise collapsing bank profits and stifling lending.
The HMI rising to 57 places it entering the low range of a robust housing market in times past-see chart.