A One-Pillar Economy

by Scott Minerd, CIO, Guggenheim Partners LLC

July 24 2013

Despite blockbuster new home sales, higher interest rates have put downward pressure on housing activity. This is highly worrisome given the importance of housing to the health of the U.S. economy.

Global CIO Commentary by Scott Minerd

With new home sales rising in June to their highest level in five years, at an annualized pace of 497,000 homes, there will be plenty of headlines declaring that the U.S. housing market is healthy. While Wednesday’s headline housing number will without doubt be viewed by many as surprisingly positive, the overriding trend remains negative.

The most important variable in the U.S. economic environment is the negative impact of higher interest rates on mortgages and the real estate market, which lately has made the United States a one-pillar economy. The yield on 10-year U.S. Treasuries has risen by 95 basis points since the start of May and we have already seen a negative trend reflected in most housing data.

Mortgage applications, housing starts, and permits are all down. Loan requests for home purchases, a leading indicator of home sales, fell in the latest week. Lower mortgage applications today mean investors can expect a drag on home sales in the near future. Total mortgage applications, which include purchases and refinancing, are also down for the sixth consecutive week.

Crucially, existing home sales (which account for more than 90 percent of all sales) contracted 1.2 percent in June. While the latest new home sales number was certainly a blockbuster, it is worth remembering such sales only account for 8.4 percent of total U.S. home sales. So while new sales were strong in June, when combined with sales of existing houses, overall sales actually declined 0.4 percent from May.

Interest rates for mortgages fell for the first time in two-and-a-half months after U.S. Federal Reserve Chairman Ben Bernanke sought to downplay expectations that the central bank will taper its asset purchases. Still, fixed 30-year mortgage rates, now at 4.58 percent, are well above the 3.59 percent rate that was available at the start of May.

Dr. Bernanke and his fellow Fed presidents can use their speeches to try hard to slow interest rates from their inevitable rise as markets reflect expectations that the central bank will start to taper its quantitative easing at some point over the next year. But, as I have noted before, they will find it is hard to put the toothpaste back in the tube.

It will be nearly impossible to ascertain the full impact of rising interest rates on housing until late August or September because of the time lag between rising rates and the impact on the data. During this time, investors will be well served by focusing on what is likely to happen further out on the horizon, as well as on the sheer importance of housing for economic growth. Housing remains the primary pillar supporting growth in output in the United States, so if activity in this market continues to teeter – and this means a mere flattening in activity, not a crash – the rest of the economy will face major problems.

Chart of the Week

Plunging Housing Starts May Slow GDP Growth

U.S. housing starts posted a monthly decrease of 9.9 percent in June. In the second quarter, housing starts fell 8.9 percent from the prior quarter, the largest drop since the first quarter of 2009. The decline in starts could add more downward pressure on U.S. real economic growth. History suggests that depressed Q2 housing starts should translate into a 0.6 percent drag on annualized real GDP growth during the same period.

U.S. HOUSING STARTS VS. CONTRIBUTION TO REAL GDP GROWTH FROM
RESIDENTIAL INVESTMENT

Source: Bloomberg, Guggenheim Investments. Data as of 6/30/2013.

Economic Data Releases

Mixed Signs in Home Sales

• Existing home sales fell in June to an annualized rate of 5.08 million. The 1.2% decrease from May was the largest drop in six months.
• New home sales increased to a five-year high in June, up 8.3% to an annualized rate of 497,000.
• The FHFA House Price Index increased a less-than-expected 0.7% in May, but continued a string of 16 straight monthly increases.
• Initial jobless claims fell to 328,000 for the week ended July 13th, a two-month low.
• The Leading Economic Index was flat in June, with half of the indicators positive.
• The Chicago Fed National Activity Index continued to show improvement in June, rising for a third straight month to -0.13.
• The Philadelphia Fed survey increased to 19.8 in July, the best reading since March 2011.
• The Richmond Fed Manufacturing Index fell to -11 in July, the worst reading since January.

Europe PMIs Indicate Expansion as Confidence Improves, China Slows Further

• Euro zone consumer confidence reached a two-year high of -17.4 in July.
• The euro zone manufacturing PMI returned to expansionary levels in June for the first time since July 2011. The composite PMI also rose above 50 to 50.4, an 18-month high.
• French and German PMIs increased across the board, with German readings indicating expansion.
• French business confidence rose in July to a 15-month high of 95.
• U.K. retail sales excluding auto sales were up for a second straight month in June, the first consecutive increase in one year.
• China’s HSBC Flash Manufacturing PMI fell to 47.7 in July, an 11-month low, with the employment sub-index at a 52-month low.
• Japan’s exports grew 7.4% in June, the fourth straight monthly increase.

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