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"Shockingly Bad Home Sales Data
Derail The Fed's Tapering Plans"
by Epic Economist
"Federal Reserve's policy hawks are expecting the central bank to reduce its massive intervention in the mortgage market as conditions in the housing market have started to look increasingly risky while home prices continue to record a relentless rise. The Federal Open Market Committee Meeting is closely watched by the biggest firms in the financial markets, especially at a time when the Fed is expected to provide an update on the progress of taper discussions amid growing imbalances both in the markets and the economy. The general view amongst financial analysts is that the Fed's leadership will send a clearer signal of the likely timeline for an official announcement at the Jackson Hole Economic Symposium in August. But in the latest meeting that happened two days ago, this was already a key concern amongst officials and market watchers, who were expecting any hint from Fed Chair Jerome Powell of whether the central bank would taper its purchases of mortgage-backed securities faster than its buying of Treasury debt.
The meeting was essentially an assessment of which scenario the central bank's committee would see as the biggest risk: the recent rise in inflation, or the recent rise in the delta variant. For over a year, the central bank has been suppressing interest rates to near-zero levels, and it also has been buying $80 billion of Treasuries and $40 billion of agency mortgage-backed securities (MBS) each month as part of the crisis-era bond-buying programs it relaunched last year at the onset of the health crisis. But economists are expecting it to start decreasing the pace of purchases this year or early in 2022. Now, Fed officials have to decide when and how to start doing that, because a single wrong turn could trigger a financial catastrophe in highly-exposed and overly-leveraged markets. They have to evaluate if the bank should taper purchases of Treasuries and MBS at similar rates or if it should prioritize scaling back purchases of MBS considering the growing imbalances of the housing market.
The Fed's record-low mortgage rates, in addition to the unprecedented cash payments issued by the U.S. government to households and a shift in consumer patterns, have all contributed to fuel an epic boom in housing. Home prices have skyrocketed by 20% this month compared to the same period a year ago, recording the fastest pace of increase since 1988. But it doesn't matter which decision the Fed ultimately makes, because it won't probably have enough impact to reverse the enormous increases in housing prices, as explained by Aneta Markowska, the chief economist at Jefferies. With inventories at record lows and builders facing a series of constraints on new construction due to a historic labor shortage and widespread material shortages related to the latest supply chain disruption, demand for housing has already started to go down. “The only way to relieve the pressure is for home builders to just create more supply,” Markowska said. “That’s really not something that the Fed can do a whole lot about".
This week's surprisingly weak home sales data for the month of June showed that due to record-high home prices, home sales tumbled by a whopping 6.6% MoM. With sales of new homes collapsing in June to the lowest level since April 2020, all of these indicators are signaling that the housing boom is effectively ready for a bust, meaning that a housing market crash may be triggered sooner than expected. Even though the Federal Reserve didn't make an explicit mention of tapering anytime soon at this week's FOMC meeting, monetary tightening could begin in stages as early as 2022, according to Danielle DiMartino Booth, CEO of Quill Intelligence. But the uncertainty surrounding the motivation behind the tapering still exists. Will the Fed taper its purchases as fears about an inflationary spike in the U.S. economy resurface, triggering the simultaneous crash of stock, bond and housing markets which Bank of America, Morgan Stanley, and even Goldman have been warning about, or will it continue to deny to talk about any tapering at least until there is some clarity on the new government infrastructure plan?
In any case, we are not that far from seeing remarkable reductions happening, simply because, as Booth told David Lin, anchor of Kitco News, interest rates would not have to rise to their historic average of 5.7% for debt payments to become unaffordable for the Treasury. The thing is: if the Fed waits too long to start acting, and inflation levels may spiral out of control very rapidly, to the point the central bank would be left with no choice other than aggressively hiking interest rates back to its historic average. And as Booth warned, once interest rates reach this level, it’s game over."