Some Housing Activity May Slow As Mortgage Rates Rise

Housing activity has been weak, according to recent data, since mortgage rates were raised by 50 basis points in October 2016. So does this mean that if the Fed starts raising rates, housing activity will remain soft? According to Goldman Sachs analysts, the answer to that question is mixed.

Housing starts have slowed

In a report dated June 26, Goldman Sachs analyst Jan Hatzius and team noted that housing starts have indeed slowed down recently.

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housing activity

They also note that new home sales in the U.S. have slowed as well, which is causing some to question the outlook for housing activity in general this year. Currently, they're estimating a 1.5% decline in residential investments for the second quarter, which is a major slowdown from the 13.7% increase that was recorded in the first quarter and the 4.9% growth rate observed in last year's second quarter.

However, they also noted that the question remains whether more improvements in the labor market and supportive fundamentals will be enough to offset the drag caused by rising mortgage rates. They point out that housing starts are now at around 1.15 million a year, but their trend demand estimate is at 1.4 million, including 200,000 demolitions and 1.2 million household formations.

Housing activity remains "resilient"

The Goldman team noted that mortgage rates have risen by about 50 basis points since October 2016, and they expect rates to rise by another 150 basis points over the next three years. They also tried to quantify the results of higher interest rates on growth in residential investments and mortgage and housing activity.

They also factored in their expectations for housing starts converging with trend demand and additional improvements in the labor market. Further, they compared the impacts of these changes to the flat interest rates before the election, combined with flat unemployment, a 1.75% increase in trend real output and 1.15 million starts in trend demand.

Housing activity to slow due to rising interest rates

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The graph above shows the results of their projections. The Goldman team highlighted that the increase in interest rates could have a major negative impact on the housing market. They add that housing activity in general was "surprisingly resilient during the first quarter despite rising interest rates. However, they also warn that weak data on housing activity during the second quarter is probably the "peak drag of higher rates."

They feel that supportive fundamentals within the housing market will "soften the blow" of rising interest rates. As a result of all their projections, they're not expecting a slightly lower level of residential investment than what they were looking for previously. They predict a 2% increase in residential investment growth next year, 1.5% in 2019 and then 2.25% in 2020.

The Goldman team feels that the majority of the deceleration in housing activity this year can be explained by rising interest rates. Despite that, they still expect "moderate growth" in housing activity due to supportive fundamentals and continuing improvements in the labor market, which they expect to offset some of the drag from the higher rates.

U.S. not the only nation preparing to raise rates

Wolf Richter warned in a blog post this week that the U.S. Federal Reserve isn't the only central bank to suddenly turn hawkish and start raising interest rates very soon.

"There are rate hikes in the air," he declared, calling this week "a veritable slugfest by central bank chiefs."

Bank of Canada seems set to raise rates very soon, with economists saying earlier this week that a July rate hike is a near-certainty. Stephen Poloz, Bank of Canada governor, told reporters that the low interest rates have "done their job." In an interview with CNBC, he downplayed the latest weak CPI report and focused on his bullish view for his nation's economy. He has also been focused on the housing bubble, saying earlier this year that the market is no longer linked to fundamentals.

Mario Draghi, president of the European Central Bank, startled the world's markets by stating that reflationary forces have replaced deflationary forces, which some took as him suggesting interest rate increases and further QE cuts. Bank of England Governor Mark Carney also indicated that rate hikes are just around the corner when he said that it will probably become "necessary" to remove some of the "monetary stimulus" they've been providing.