When the dollar goes down, things priced in those dollars have a sneaking tendency to go up.
And when inverse correlations to the dollar build like they have over the last 6 months, fundamental conditions corroborate and consensus net long speculative positioning crescendo’s to its highest level ever, you get the type of oil reflation we’ve seen over the last 6 months … and, in tow, follow all things inflation expectations related.
Below is the Oil vs 2Y Yield correlation over the last 6 months. 10Y Yields, swaps, breakevens all plot pretty much the same.
That expedited, large-scale changes in interest rates significantly impact performance in rate sensitive assets is basically tautological.
Inclusive of the recent ‘correction’, the -1,200 bps YTD performance spread between Utilities and Consumer Discretionary sits as the latest style factor/sector level evidence.
That's the broader, top down contextualization.
Rates ↑, Housing ? ....
Alongside any sharp backup in rates we get asked about the impacts to housing, particularly in the present instance given the material outperformance across the builders and primary industry ETF’s over the past year.
Below is a truncated redux of a larger analysis we conducted previously. The objective here is to simply re-profile historical periods of expedited rate increase and the associated implications for housing.
There have been three notable episodes of expedited increase in mortgage rates over the last 25 years.
Below we highlight the impacts to Affordability, Housing Fundamentals and Housing related equities:
Affordability: Normal oscillations in interest rates generally have only a marginal effect on the actual decision to purchase a home but they do have a direct impact on affordability.
The easy rule-of-thumb is that a 1% increase in mortgage rates equates to an ~10% decrease in affordability. With rates on the 30Y FRM up +51bps off the latest September low, the increase represents ~5% hit to affordability.
Bear in mind, however, that current mortgage rates are essentially equal to where they were a year ago (Feb/March) so the Y/Y impact is decidedly less sensational.
The Impact to Housing Fundamentals:
Summarily, volumes show a higher relative sensitivity to interest rate changes with the magnitude of impact loosely related to the pace of increase. Home price growth, in contrast, has generally exhibited a muted sensitivity to rapid rate changes. While the rate of increase in price appreciation has stalled alongside rate rises, 2nd derivative HPI has typically stabilized from a RoC standpoint as opposed to reversing towards outright negative growth.
- October 1993- December 1994: Mortgage Rates rose +240 bps over the span of 14-months. Sales of existing single-family homes declined ~19% from peak to trough over the compressed, corresponding cycle. Home price growth started at 2.3%, rose to +3.0%, then decelerated to +1.2% over the period.
- October 1998 - May 2000: Mortgage Rates rose +180 bps over the span of 19-months. Sales of existing single-family homes declined ~6% measured from period peak to trough values although there was notable sales volatility with purchase demand moving in both directions during the period. Home price growth, meanwhile was largely flat and actually accelerated over the last six months of the period.
- December 2012 – September 2013: Mortgage Rates rose +120 bps over the span of 10-months. Sales of existing single-family homes increased ~+6% over the period while price growth continued its existent acceleration before flatlining into 2013 year end.
Sensitivity of Housing Related Equities:
Given that we're looking at time periods back to the early 1990s, we're more constrained in which names we can look at, so for our proxy we're using the S&P 500 Homebuilding sub-index.
Here's what happened.
- October 1993- December 1994: Mortgage Rates rose +240 bps over the span of 14-months. The S&P 500 Homebuilding index lost 33% of its value over that 14 month span. By contrast, the S&P 500 was flat over the corresponding period.
- October 1998 - May 2000: Mortgage Rates rose +180 bps over the span of 19-months. The S&P 500 Homebuilding index lost 29% of its value over that 14 month span, but the S&P 500 was up 44% making the relative underperformance a whopping 73%.
- December 2012 – September 2013: Mortgage Rates rose +120 bps over the span of 10-months. The S&P 500 Homebuilding index lost 3% of its value over that 14 month span. By contrast, the S&P 500 was up 19% over the corresponding period so the relative underperformance was 22%.
The average of these prior periods was a negative absolute return of -22% and a negative relative return of -42% vs the S&P 500.
Conclusion: In short, housing fundamentals have, historically, shown moderate sensitivity to compressed, large-scale interest rate changes. The stocks, particularly the Homebuilders, however, are very highly sensitive to rate tantrums. The Mortgage Insurers are generally the rotational play when the specter of rising rates intensifies.
