Monday, 28 May 2007

US economic rebound could leave housing market behind

Last week saw a large rebound in new home sales in the United States. However, the rebound in the US housing market may not prove to be sustainable over the next few months.

On 24 May, the Commerce Department reported that sales of new single-family homes in April rose to an annual rate of 981,000 units. This was 16.2 percent higher than the pace of 844,000 in March, the biggest jump in sales in 14 years.

The sharp rise in sales helped bring the number of new homes for sale down to 538,000 in April from 546,000 in March. This represents 6.5 months of sales, a sharp fall from 8.1 months for March.

The housing data last week were not completely unambiguous though. For one, falling prices, a negative for the housing market, played a part in boosting sales. The median price of a new home fell to $229,100 in April from $257,600 in March.

Furthermore, the day after the Commerce Department data were released, the National Association of Realtors reported that sales of existing homes fell 2.6 percent in April to an annualised pace of 5.99 million units, the lowest since June 2003.

The data on existing home sales may not be so significant though. Existing home sales are counted on closure of a sales contract, unlike new homes sales, which are based on the signing of a sales contract or the acceptance of a deposit. Therefore, existing home sales are less timely than new homes sales as an indicator of the latest trend in the housing market.

Other reports released on 24 May had also pointed to strength in the US economy.

The Commerce Department reported that orders for durable goods increased by 0.6 percent in April while March orders were revised up to show a 5 percent increase. Orders for non-defense capital goods excluding aircraft, often used as a proxy for business investment, rose 1.2 percent in April after increasing 4.4 percent in March.

The Labor Department reported that initial claims for unemployment insurance rose by 15,000 to 311,000 in the week ending 19 May. However, the four-week moving average fell by 3,500 to 302,750.

In the face of such positive data, the yield on the 10-year Treasury note rose last week by 6 basis points to 4.86 percent, bringing it close to its high for the year.

In fact, the latest data reinforce the view of many economists that US economic growth is in the process of forming a bottom and should improve over the rest of the year. A stronger economy could help the housing market recover.

However, there are several headwinds. The inventory of unsold new homes remains high compared to historical norms. In addition, banks have recently tightened lending standards in the wake of problems in the subprime housing market.

Ironically, an improving economy could itself undermine home sales by pushing interest rates up. As the accompanying chart shows, the mortgage rate has historically played an important part in driving new home sales. The falling rate since the middle of 2006 (note that the mortgage rate is on a reverse scale on the chart) has surely helped to arrest the deterioration in the housing market.

If the rest of the US economy continues to improve as many economists expect, then we may have seen the low in the 10-year Treasury yield for the year. Indeed, yields should go up from here on.

This in turn should put a floor on the mortgage rate. If the mortgage rate stays around current levels for the rest of 2007, the current favourable trend in its year-on-year change starts to reverse around the middle of the year.

Such a reversal could put an end to the nascent recovery in the housing market.

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