Stocks Fall, Rates Surge as Fed Outlines End of QE; Real Estate in Focus
Stocks are lower, while treasury yields continue to surge Thursday after Federal Reserve Chairman Ben Bernanke signaled that the end of QE is near. Bernanke indicated that the Fed's $85 billion monthly bond buying program is expected to taper off later in the year with the goal of ending bond purchases in mid-2014.
On top of yesterday's afternoon slide, the Dow is down another 238 points Thursday, the Nasdaq is down 49 and the S&P 500 is down 27.
The 10-year Treasury yield last traded at 2.40%, up nearly 10% since the Fed announcement. The 30-year Treasury last traded at 3.47%, up nearly 4% since the Fed announcement. To illustrate the carnage in bond land, the 10-year is up 46% since the beginning of May. The 30-year is up 22% during that time.
Rising interest rates create various issues, but most notably for main street is in the real estate market. Rising mortgage rates threaten to put a damper on the nascent real estate recovery.
All is not lost, however. In his press conference yesterday, Bernanke said the Fed will not sell agency mortgage backed securities (MBS) during the process of normalizing monetary policy. "While participants continue to think that, in the long run, the Federal Reserve's portfolio should consist predominantly of Treasury securities, a strong majority now expects that the Committee will not sell agency mortgage backed securities (MBS) during the process of normalizing monetary policy, although in the longer run limited sales could be used to reduce or eliminate residual MBS holdings," Bernanke said.
While Bernanke & Co. may not be selling mortgage backed securities (MBS) any time soon, over the near term they also won't be the biggest buyer in the market - theoretically pushing down prices and pushing up yields.
On short term rates, Bernanke indicated they will stay at the 0 to 1/4 percent federal funds rates at least as long as the unemployment rate remains above 6-1/2 percent. Bernanke also clarified that a decline in the unemployment rate to 6-1/2 percent "would not lead automatically to an increase in the federal funds rate target, but rather would indicate only that it was appropriate for the Committee to consider whether the broader economic outlook justified such an increase." He said 14 of 19 FOMC participants indicated that they expect the first increase in the target for the federal funds rate to occur in 2015, and one expected the first increase to occur in 2016. He also said if an when rates the increase will "likely to be gradual."
Turning the focus back on real estate, homebuilder stocks - one of the strongest groups ytd - are getting pummeled.
PulteGroup, Inc. (NYSE: PHM) is down 6%, KB Home (NYSE: KBH) is down 4.5%, Lennar Corp. (NYSE: LEN) is down 4.5%, Toll Brothers Inc. (NYSE: TOL) is down 5.8%. The sector as a whole, represented by ETF SPDR S&P Homebuilders (NYSE: XHB), is down 4.2%.
Homebuilders have benefited from ultra-low interest rates as home buying activity has increased sharply and the purchasing power of buyers was greatly increased by the low rates.
While rising rates threaten the pace of the real estate recovery, over the near-term rising rates may push some on the fence buyers into the market. Today, data on existing home sales illustrated this phenomena. Total existing-home sales rose 4.2 percent to a seasonally adjusted annual rate of 5.18 million in May from 4.97 million in April, and is 12.9 percent above the 4.59 million-unit pace in May 2012. The national median existing-home price for all housing types was $208,000 in May, up 15.4 percent from May 2012.
Overall, Bernanke is looking to gradually wean the economy off life support. This is a good thing. However, markets need to adjust to the new reality that the biggest buyer in the treasury and MBS market is stepping back soon, putting an upward bias on interest rates. This threatens the real estate recovery, not to mention the real economy.
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