As a person who studies and writes about markets for a living, I have a responsibility to stay informed. I check interest rates every single working day - and often more than just once! I glance at the 10-year Treasury yield at least six or seven times a day, and might even sneak a peek at the 30-year, just to shake things up a bit.
It doesn’t hurt that my prior occupation was as a bond trader, so the interest rate markets are near and dear to my heart. But the unvarnished truth is that most of the time, the small degree to which interest rates move simply doesn’t matter...not one bit.
For example, last Thursday the 10-year yield was falling on geopolitical worries in the Middle East. The yield dropped from 1.91% to 1.89%, signaling investors were getting cautious. By late morning, yields had turned around, walking up to 1.92%, and at the end of the day the yield was just over 2.00%. What a move!
Well, it is if you’re trading bonds, which is basically poker over the phone with millions of dollars on the line. But when it comes to deals like purchasing a home or buying a car — things that affect everyday people in everyday life, not just bond traders — a move from 1.90% to 2.00% is almost meaningless.
And that’s where the problem lies.
Low Interest Rates Fail to Spur Home Buying
For six long, yield-less years, the Federal Reserve has done its best to push down interest rates. They were banking on the theory that cheaper debt entices consumers to borrow, and borrow more. Operating with that logic, the increased credit would aid the economic recovery, particularly in the housing market… because everyone knows that lower rates force people to buy homes, right?
Apparently, not so much.
New home sales shot up 12% in February, reaching 539,000 units. That would be great news — if this weren’t near the lows of previous recessions! In prior economic expansions, new home sales fluctuated between 600,000 and 800,000 units, except in the 2000s when sales flew off the charts at well over one million per year. Only in severe downturns did we reach 500,000 units, and yet that’s where we are today, after six years in recovery.
Existing home sales are at roughly five million units per year after falling to just over four million in 2008 and 2010. Before that, we last saw five million units sold in the mid-1990s. Keep in mind that these housing numbers are not adjusted for population. We’ve added tens of millions of working age adults to our economy since the 1990s, and over 100 million since 1963. With so many more people, and interest rates so low that we are practically giving away cash, the real estate market should be on fire! But it’s not.
At this point, the relative interest rate charged on mortgages is almost irrelevant. The numbers are so small as to not be a major part of a buyer’s calculation. If a homeowner borrowed $250,000 for 30 years at 3.99% (the current mortgage rate), the monthly principal and interest payment would be $1,192. If interest rates shot to the moon next week and landed at 4.50%, the mortgage payment would move up by just under $75.
Increasing the payments by $900 per year is nothing to sneeze at. This does increase the total payments by $27,000 over the life of the loan. But is the increase going to break a deal for a quarter-million dollar home? That seems highly unlikely. Borrowers understand that current mortgage rates around 4% are exceptionally cheap. These are numbers that seemed unimaginable just 10 years ago.
Now, they’ve been sitting around this level for almost half a decade. For rates to start impeding home purchases, they would have to be a lot higher than 4.5%, or even 5%. Which brings me back to the lack of home sales. It’s not interest rates holding back buyers. It’s income.
A Job Recovery Created with Smoke and Mirrors
People aren’t making enough money to buy homes. Until their incomes grow, they won’t have what is required to make that purchase and strike out on their own. The annual rate of household formation is volatile, but it averaged between one million and 1.25 million from the 1980s up to the financial crisis. After 2008, household formation sank to an annualized rate of 300,000 to 800,000, which is amazingly low, because so many millennials have been added to the working population over the last seven years.
This illustrates something we’ve been highlighting in our Dent Employment Index for over a year — while the economy has added jobs, the largest share of those new positions have been at the bottom of the wage scale. This is the trend we expect to see continue when the unemployment figures — and our next report — are released on Friday, April 3rd.
The calculation of unemployment doesn’t care if a new job pays $18,000 per year or $180,000, but it sure makes a difference to the worker, not to mention the economy.
Without a significant increase in higher paying employment, we can’t expect real estate to surge anytime soon — no matter what happens to interest rates.