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12 10 2015 | by Victor Xing | Economics

U.S. housing market and FED’s policy normalization

The U.S. housing market’s performance in 2016 will depend on long-term Treasury yields’ response to Federal Reserve policy changes and behaviors of long-term bond yields across developed economies (Japan, Germany, for example).
The following happened during the FED’s previous hiking cycle:
  1. The cost of 30 year fixed rate mortgages (blue) is highly correlated with 10 year Treasury note yield (dark red)
  2. The Federal Reserve rapidly raised rates (gold) from 2004 to 2006 to try to push up long-term bond yields (10 year Treasury yields) and cool the housing market
  3. 10 year and 30 year Treasury yields failed to react to the rate hike
  4. Cheap funding continued to fuel the housing bubble
Housing market - mortgage rates vs. broader interest rates
This came to be known as Greenspan’s Conundrum:
In February 2005 Federal Reserve Chairman Alan Greenspan noticed that the 10-year Treasury yields failed to increase despite a 150-basis-point increase in the federal funds rate as a “conundrum.” This paper shows that the connection between the 10-year yield and the federal funds rate was severed in the late 1980s, well in advance of Greenspan’s observation. The paper hypothesize that the change occurred because the Federal Open Market Committee switched from using the federal funds rate as an operating instrument to using it to implement monetary policy and presents evidence from a variety of sources supporting the hypothesis. The analysis has implications for central banks’ interest rate policies.
Others also pointed out the declining yields in Japan (due to BOJ’s QE program) also pushed down yields across developed economies, further constraining Federal Reserve’s ability to affect long-term rates (and in turn, their ability to affect mortgage rates).  Many policy makers are concerned that this may happen again during the (expected) upcoming tightening cycle.
At the moment, the most effective tool to push up long-term rates also happen to be the most disruptive – selling long-maturity Treasury securities and MBS currently held on FED’s balance sheet.  Many investors hope it won’t come to that, and others (including myself) expect the FED to increase the pace of their rate hike if financial conditions (an aggregate measure of borrowing rates, dollar valuation, stock valuation, credit spreads) do not tighten as a result of FED’s rate hike.
As for the housing market – it will depend on one’s rates view – if one believes long-term interest rates will steadily rise, then the effect of higher funding cost may constrain housing affordability (there is also a factor of overseas demand that is insensitive to borrowing cost in the U.S. – for example, Chinese buyers have been a significant source of housing demand in the Southern California area).  Conversely, if one takes a view that long-term bond yields would be mostly unchanged, then domestic housing demand would be mostly unaffected.
Original Quora article

Next article12 08 2015 | by Victor Xing | Economics

October JOLTS – a look at labor market flows