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By New_Deal_democrat April 19, 2018 1:08 pm
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Do interest rates still matter for housing?

For the last five years, my housing posts have followed a mantra:

  • interest rates lead sales
  • sales lead price
  • price leads inventory

And there is data going back to the 1950s in some cases to back up that relationship. Now, that doesn't necessarily mean that causation couldn't run in the reverse direction, for example:

  • low inventory causes prices to rise

But the leading/lagging relationship should be intact, as in:

  • high prices (eventually) cause sales to decline
  • after which, prices go down

But in the past five years, mortgage rates have had (some, but) little effect on sales. 


Here is a graph of the YoY change in interest rates (inverted, green) compared with the YoY change in single family housing permits from the 1960s to 2004: 



There was virtually a 1:1 relationship. If anything, housing was more volatile than interest rates.


Let's compare that with the last 5 years:



Since mid-2013, single family housing permits have grown at 70k YoY +/-25k almost relentlessly. A 1.25% increase in interest rates at the end of 2013 led to only a two month flatlining of permits.  Measured this way, last year's increase of up to 0.60% in interest rates barely made a dent in YoY growth in permits (although for 6 months they did fail to make new highs).


Still, it's at least possible that hurricane related building delayed the onset of the impact of higher interest rates, which possibly showed up in Tuesday's housing permits report.


Let's discuss that report. The below graph measures total permits, single family permits, and multifamily permits on a monthly basis:



Of interest, single family permits (the least volatile series) did fall to a six month low.


When we measure quarterly to take out noise:



we see a nearly relentless upward trend overall, with a flattening of single family permits q/q, while multiunit permits increased sharply.  Since multifamily units (condos, apartments) are something of a substitute good, sometimes in the past they have continued to increase after the peak in single family building


In the meantime, the more volatile starts (measured quarterly in the graph below) also made new highs, but have been lagging permits:




As a result, there's an increasing backlog in houses for which there are permits, but haven't actually started construction yet:




This augurs for continued increases in housing starts in the months ahead.


Now that I have made the case that interest rates have had diminished impact on housing in the last five years, let me note that they have had *some* effect.  Because when we measure the YoY% change in permits (rather than measuring in 100,000's), a significant slowdown *does* show up:




The most likely reason for the diminished impact of mortgage rates is what I have called "the demographic tailwind."  In the below graph, I have subtracted 75,000 from the YoY number of housing permits. measured quarterly to reduce noise:




This is considerably closer to a 1:1 fit.  If anything, this demographic tailwind is increasing, as the number of young adults of home-buying age continues to swell.


That's why several months ago I suggested that it would probably take a minimum of a 1.75% increase in mortgage interest rates to 5% or over for a sustained period of time to cause the market to roll over.


So I still think mortgage rates lead sales. But more than anything else the demographic tailwind means that it will take a bigger change in rates to have a large effect.


It also seem fairly clear that sales continue to lead prices -- but prices haven't increased enough in real terms to have a decisive effect either. That will be the subject of a different post.

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