THE BASIS POINT

Serious People Are Talking Of A Return To 1970s Style Inflation. Is It Real & Will It Kill Housing?

“Serious people are talking of a return to 1970s-style inflation.”

This quote jumps out from a late-February Economist piece. Below is a link to that and a handful of their other recent inflation pieces. Inflation causes rates to rise, which can kill off the housing health, which has been one of the most healthy drivers of broader economic growth in the pandemic.

So inflation could in fact kill housing if it were to spike materially.

Is that going to happen? Here are a few quick thoughts:

– The bond market is most sensitive to inflation because inflation erodes the value of future cash flows a bondholder will get.

– Mortgage rate markets are tied to bonds because home loans are eventually packaged into mortgage bonds.

– Those mortgage bonds (aka mortgage backed securities or MBS) have risen about 0.5% since mid-February as infaltion fears crept into the market.

– When inflation fears hit mortgage bond investors, they sell bonds.

– When bonds sell, the bond price drops and the yield — or rate of return — rises.

– This bond selling — and resulting rate rising — has been happening for a few weeks.

– But here’s the thing: bond markets are the “smart money.” They’ll always act first.

– So while inflation fears helped trigger a meaningful short-term 0.5% spike in rates, it’s not enough to derail the housing market.

– And all the projections for housing and loan volume for this year account for these rate rises as we move through 2021.

– Let’s make sense of this by looking at the quarterly rate projections in the image below.

Home Prices, Mortgage Rates, Size of Mortgage Market - Outlook 4Q20 to 3Q21 - MBA, The Basis Point_2021-02-24

– See how 4Q20 and 1Q21 both show 30-year fixed mortgage rates projected at 2.8%, and how 3Q21 shows 3.3%?

– Well, what’s happened is that we’re getting close to 3.25% as of now.

– This happens when bond markets act first on inflation and ask questions later. It’s very consistent in all market cycles.

– BUT … if it holds for awhile — which it often does after an initial spike — then these projections will generally play out in a similar way as shown in the table.

– That goes for rates. And it also goes for home sales and loan volumes, all of which are very healthy.

– So let the headlines do that they may, and know that this headline chaos usually calms down.

– Of course we can see inflation take off more aggressively, especially as stimulus checks and state re-openings work their way through the economy.

– But generally this should even out.

– Comment below with questions, and here’s a bunch of those links as promised if you want to get into the weeds on inflation intellectualism.

 
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