The latest reporting of Weekly Mortgage Applications by the Mortgage Bankers Association (MBA) produced an interesting result. While overall activity dropped significantly on a spike in mortgage rates, applications tied to home purchases actually increased. This begs to question whether a counter-intuitive allowance of rate increase might actually help the housing market. Before I lead you on too far, you should know that I'm relatively certain the answer here is no, and I'll tell you why.
The MBA's Market Composite Index, measuring overall mortgage application activity, dropped sharply 7.4% in the period ending August 17. The decline was clearly driven by a dead stall in refinancing activity, with the MBA's Refinance Index falling 9.0%. This was all driven by a marked increase in mortgage rates through the period.
Average Contracted Mortgage Rates & Changes Across Loan Types
30-Year Fixed Rate w/ Conforming Loan Balance
+10 Basis Points
30-Year Fixed Rate w/ Jumbo Loan Balance
30-Year Fixed Rate w/ FHA Backing
15-Year Fixed Rate Mortgages
Yet, purchase activity increased through the same period, with the MBA's Purchase Index rising 0.9%. Now, you could argue that the purchase of a home is not a nimble action like the refinancing of a mortgage is, and that the increase therefore is more likely reflective of rates and other factors over the last several weeks. This is an important point and the best argument against the thesis that rising rates might drive home buyers on the sidelines into action.
Still, many in the industry believe that falling home prices (over the longer term) and falling mortgage rates have had many prospective home buyers waiting things out. The same theory would thus imply that a sudden jolt higher for mortgage rates in conjunction with the latest increase in home prices could help the housing market. The latest action might incorporate such a psychological draw, with some number of special cases waiting for the best time to buy real estate. However, it really is more likely just due to the length of time it takes to decide on, contract for and buy a home, and to be rid of any old property held in an illiquid market.
It would be a risky game to play if the Fed were to actually attempt to target higher rates now, assuming they could. I say that because of the great demand for U.S. debt instruments as a relative hedge against external risks. This works to drive rates lower. Most economists would likely warn that a rate increase now would only serve to send the U.S. economy into recession. Our economic recovery out of the financial crisis has been burdened by the tighter lending regulation and higher expectations of mortgage lenders. Institutions like Bank of America (NYSE:BAC) are still working through bad loans and fending off demands of mortgage-backed security holders and insurers, who are demanding to be made whole for alleged faulty loans written by BofA, J.P. Morgan Chase (NYSE:JPM), Citigroup (NYSE:C) and others.
Thus, on net, higher rates would certainly hinder economic recovery and cyclical housing activity. Recession happens to be my current expectation for our economy as is - for this year if not in 2013. It's the reason why I've been recommending stock investors avoid the high-flying housing stocks like Toll Brothers (NYSE:TOL), PulteGroup (NYSE:PHM) and D.R. Horton (NYSE:DHI), which have been benefiting from demand for new homes in a special situation - tight supply environment; and from multi-family residential property construction for rental; and from market share gains from smaller builders. The SPDR S&P Homebuilders (NYSEARCA:XHB) has gained dramatically over the course of the last year. Still, I feel the more important macroeconomic driver will force a tide too strong against them soon enough, and at least see it as a risk not worth taking with other options available for capital. But the new home market and its builders are part of a special situation, and relatively small with respect to the overall market.
Today, Existing Home Sales were reported 2.3% higher, but that followed June's sharp drop in activity. Sales at a 4.47 million annual pace actually fell short of economists' expectations for 4.5 million for July. So, despite the headlines, the real estate environment is still far from robust and thus vulnerable to economic shock catalysts like rate increase.
In conclusion, I think it's safe to say that while there likely is a curious draw provided by higher home prices and mortgage rates for a few shy real estate watchers, on net there would be an overwhelmingly destructive effect to the overall economy and the real estate market by a rate increase today.
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.