Fundamentals Pointing To A Weak Housing Market

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 |  Includes: IYR
by: Katchum

With the recent surge in the mortgage yields, let's see how the housing market (NYSEARCA:IYR) is doing. The two key metrics to consider are mortgage rates and household income. Let's analyze the mortgage rates first.

Historically, there has been a high correlation between 30-year U.S. treasuries and 30-year mortgage rates (Chart 1). The chart shows that the 30 year U.S. treasury yield has spiked upwards starting in 2013, so I expect that 30-year mortgage rates will spike upwards too. 30-year mortgage rates have already gone up from 3% to 4.9%, which had negative consequences for the real estate market, which is not priced in yet in the housing market index.

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Chart 1: Correlation between 30 year treasury yield and 30 year mortgage yield
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As Zero Hedge reports, the affordability of housing is declining rapidly with rising mortgage yields. Every percentage increase in yields on 30-year mortgages will result in a 10% decline in affordability as the chart shows. If yields continue to go up to 6%, affordability would have declined about 40% since 2013.

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Chart 2: House Purchasing Power
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The question is will mortgage rates go up further? I think so, because in the last FOMC meeting, Ben Bernanke said there is a probability that he would reduce bond purchases from $85 billion a month to $65 billion a month and cease buying bonds somewhere next year. If you know that the Federal Reserve buys the majority of these bonds, who other than the Federal Reserve will buy these bonds if QE stops? Foreigners have already reduced their U.S. treasury holdings in April 2013 and I think this reduction in U.S. treasury holdings from foreigners will continue. As maturing debt needs to be rolled over, I expect higher yields coming in the treasury market. On top of this, we have the debt ceiling of $16.73 trillion which is one of the main culprits of rising bond yields. With all this, I expect higher bond yields and as a result, higher mortgage rates.

Chart 3: U.S. Treasury Holdings from Foreigners
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So the outlook on mortgage rates is not positive, which takes me to the second part of the analysis. While mortgage rates go up, there is more bad news on the household income level. Wages aren't going up because inflation is low (chart 4). On top of that unemployment is expected to rise back to 7% as Ben Bernanke points out here.

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Chart 4: Wage Inflation Vs. CPI
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So how are people going to afford buying homes at these rising yields? In fact, disposable income has declined precipitously. Savings rates are at near zero (chart 5).

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Chart 5: Savings Rate
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And we can also see that the amount of savings that are available for investment are declining in a rapid pace (chart 6).

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Chart 6: Gross private saving minus gross private investment
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Conclusion:

The only reason the housing market index is rising is because hedge funds are speculating on a housing recovery. The fundamental story however is different. U.S. citizens have less savings, are on record amount of disability checks and food stamps, with a rising unemployment rate and on top of that there is a declining affordability of home purchasing power due to rising mortgage rates. If these fundamentals stay in place, I expect a weak real estate market going forward.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.