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Demystifying the Economics of Housing

Editor’s Note: This feature originally appeared in the May issue of DS News, out now.

Dwight Johnston has over 30 years’ investment experience with financial institutions in a variety of roles. For the past 15 years, beginning with his role as Chief Economist for Western Corporate Federal Credit Union, Johnston has focused on economic and market information and education for credit unions. He is the author of a popular “Daily and Long-term Economic Commentary” website and is a frequent speaker at credit union board planning sessions and industry conferences. Johnston’s mission is to demystify economics and the markets. He is the author of DJ’s Economix, a daily and long-term analysis and commentary on financial markets and the economy.

In 2017 the Fed raised interest rates three times. With more hikes expected this year, what impact do the Fed's actions have on mortgages?

Those three increases didn't affect mortgage rates until the very end of the year when the tax reform bill passed. When it comes to this year, it all hinges on how the bond market assesses the economic outlook. I would expect the Fed to raise rates three times again this year, but if the economy stumbles, midyear rates would stop going up and possibly even start going back down.

But the flip side of that, if inflation does go up more than expected this year the bond market would then have to make a big adjustment because the yield curve has flattened a lot over the last few years. It's started steepening in January, but it still is nowhere near a normal yield curve. When the economy is doing well, inflation moves higher. You could see longer-term mortgage rates go up. That's why it's so unclear right now what the path is going to be this year. Right now, everything points to a stronger economy and rising inflation. We should end up with something in the order of three more rate increases by the Fed and a similar move in the long-term rates. A 10-year note, which is about a 2.8 percent bond interest-rate basis points today should be about 3.5 percent by the end of the year. This would probably tack on 75 basis points to your mortgage rates.

Do you predict Jerome Powell differing in his stance from the path Janet Yellen set forth?

When Powell was first nominated, we thought he was a Yellen clone because whenever she spoke, he would basically say the same thing. But we've found that this doesn't mean anything now that he's the chairman. In the last couple of speeches Yellen made before stepping down, she was very positive on the economy, more so than in her entire four years. When Powell testified before Congress, the prediction was that he would be a little more subdued. But in fact, he was as optimistic, if not more so than Yellen. That caught people by surprise. The thought that he might not want to be as aggressive at raising rates went out the window.

What other economic factors should we be watching to predict the health of the housing market this year?

First and foremost, continue watching the jobs numbers. That's your easiest and best way to gauge how the economy is doing. Second, I would put in the inflation numbers. Especially over the next three months, or four months, because year-over-year we could see a fairly significant rise because of some low numbers last year that will be dropping off that year over year equation. Third, it’s important to look at how the bond market processes all of this information. Last is continuing to watch the Fed.

The only homeowners that have to worry a lot about the Fed are those with adjustable rate mortgages. Especially those tied to Libor, which has gone up substantially over the last couple of years.

With jobs and inflation being the most critical factors for you, what are these areas currently telling us?

Right now jobs numbers have been surprisingly strong. A lot of times you'll run into a hiccup around the first of the year, but the numbers have been off the charts. There was strength through broad sectors, and the tax cuts to businesses bode well for capital spending and hiring. Barring any train wreck that might be caused by a trade war, we should see continued good gains in jobs. Despite this many industries are having trouble finding people to hire. That will constrain job growth somewhat.

The inflation rate has been steady, around 1.8 on the core CPI number. However, over the next four months, the low numbers from last year will be dropping off that. The next one we get should reflect a .1 drop off from last year. Even if you get only a .2 increase, you'll see a .3 increase in the year-over-year rate. The bond market is not going to like seeing that, even though they should be aware it's a possibility.

About Author: Rachel Williams

Rachel Williams attended Texas Christian University (TCU), where she graduated with Magna Cum Laude with a dual Bachelor of Arts in English and History. Williams is a member of Phi Beta Kappa, widely recognized as the nation’s most prestigious honor society. Subsequent to graduating from TCU, Williams joined the Five Star Institute as an editorial intern, advancing to staff writer, associate editor and is currently the editor in chief and head of corporate communications. She has over a decade of editorial experience with a primary focus on the U.S. residential mortgage industry and financial markets. Williams resides in Dallas, Texas with her husband. She can be reached at [email protected].

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