That headline question is the focus of the May Economic and Housing Outlook produced by Freddie mac's Office of the Chief Economist. The economic team, headed by Leonard Kiefer, Deputy Chief Economist, notes that housing stumbled in 2013 when rates rose by a full percentage point in May and June of that year. Sales slowed in response and are only now recovering to their levels before that event. Are we due for a repeat?
The first quarter of 2015 showed some economic weakness. Real GDP growth was preliminarily estimated at 0.2 percent annualized but indications are the final number will dip below zero. The second quarter looks better but below 2014 returns yet improved European economic news has driven U.S. interest rates higher and Freddie Mac expects they will continue to rise over the remainder of this year. How fast will be a function of international and domestic economic growth, Federal Reserve policies, and what markets expect from these three factors. There could be significant volatility around any Fed policy changes with expectations that the central bank may raise the Fed Funds rate as early as next month but more likely in the fall. If the Fed continues on its current path, rates will likely start rising by midsummer although they may have already started the expectations cycle.
Rates will affect homebuyer affordability and thus can be expected to slow both home sales and new construction. The latter as well as declining business investment will in turn slow economic growth. How much will affordability be affected and how will housing market respond?
Current affordability is high. Freddie Mac estimates that in the first quarter of the year 133 of the 163 metropolitan areas it tracks a median priced home was affordable to a median earning household. The areas that are unaffordable by the metric are the high cost markets of the Western US and the eastern seaboard. Much of the Midwest and South (with the exception of Florida) remains highly affordable.
But affordability calculations are highly interest rate sensitive. With incomes and house prices held constant, an increase in mortgage rates to 5 percent would reduce the number of affordable metros to 108. The figure below shows how a traditional affordability metric (no more than 25 percent of gross monthly income going to monthly principal and interest payments) responds to rising interest rates. A purchase of a $200,000 home financed with a 30-year fixed rate mortgage by a household earning $50,000 per year becomes unaffordable at a mortgage rate of about 4.74 percent.
During the "Taper Talk" period in May and June 2013, interest rates rose, supposedly in reaction to Fed Chair Ben Bernanke's comments about tapering off purchases of bonds, however Freddie Mac notes that Bernanke spoke out on June 19, well after rate increases had begun.
In May of 2013 the 30-year fixed rate mortgage was a 3.40 percent and rose to 4.46 percent by the end of June. At the beginning of May 2015 Freddie Mac's Primary Mortgage Market Survey put the rate at 3.68 percent and it rose 0.17 point over the subsequent two weeks.
Back in 2013 the rate increases were followed almost immediately by a decline in applications for home purchase financing. Home sales responded slower than purchase applications, peaking on a seasonally-adjusted basis in July of 2013, but declining sharply thereafter. In 2015, purchase applications have been trending higher throughout the year, but started to level off in early May.
So far, Freddie Mac notes, there has not been a 2015 Taper Talk-like event but interest rates seem to be rising at least partially in anticipation of a Fed policy change. "With liftoff looming we could see rates in 2015 follow similar pattern."
The Outlook captures how events of 2013 look compared to thus far in 2015 in three graphs:
The company's economists add that while the 2013-2015 comparisons are striking, not all economic conditions are the same. Since 2013 the labor market has added over 5 million additional jobs, the unemployment rate fallen by more than 2 percentage points and housing markets are generally in much better condition. Rising rates will squeeze home affordability and in some markets where costs are already high will make homeownership even less accessible but Freddie Mac says housing looks strong enough to weather moderately rising rates but need real income growth to support homebuyer demand. "Our analysis has shown that while many markets look highly affordable today, the story can change quickly if interest rates and house prices rise without any offsetting income growth."
Based on some recent events the economic team has revised some of its earlier economic projections. Real GDP growth in the second quarter has been downgraded from the 3.0 percent projected in April to 2.5 percent but third quarter growth was upped to 3.3 percent. "Overall we estimate Real GDP will grow 2.3 percent in 2015, revised from a 2.6 percent growth previously estimated." Quarterly CPI forecasts were also revised up; increased for 2015 by 0.2 percent to a 1.0 percent increase and raised for 2016 by 0.3 percent to a 2.3 percent increase for the year.
Unemployment rate projections for 2015 and 2016 were unchanged from the prior month at 5.4 percent and 5.1 percent respectively and interest rate projections were unchanged from April's forecast of an average of 4.0 percent for 2015 and 4.9 percent for 2016. Home sales and housing starts were also kept the same at 5.6 million and 1.18 million respectively in 2015. House price growth was revised upward to 4.5 percent and projections for mortgage originations were raised by $50 billion to $1.35 trillion, tapering a bit to 1.275 trillion in 2016 as refinancing declines by 50 percent.
