The housing market reacts to the tax deal (Photo: Jessica Rinaldi/REUTERS)
Some are worried that the tax deal and other recent efforts to boost the economy will have an unintended and potentially troublesome casualty: The Housing Market.
Rates on the 10-year Treasury bond have spiked in the past week since news that a tax deal, which would keep the US income tax rate at Bush-era levels and temporarily lower others, between the White House and Republicans was in the works. Some Democrats are wary about giving into the extension of lower rates for the rich, but Time’s Alex Altman reports today that the deal is likely to pass. That should be good news. Some studies say the deal, by lowering taxes and stimulating the economy, could add as many as 2.2 million jobs during the next two years. It also will add nearly $900 billion to the deficit and is already increasing fears that the government will not be able to pay off its debt. In the past week, the rate on the 10-year Treasury bond has jumped to a recent 3.3%, from 2.9%. The jump, which caps a nearly 1% run up in 10-year yield since early October, in turn is making some nervous about the housing market. But those fears may be misplaced. Here’s why:
When it comes to the housing market, the 10-year rate is the one to watch. That’s because most banks tend to base their mortgage loans on the 10-year Treasury. If the 10-year goes up, so, too, do home loan rates, and vice versa. And when mortgage rates go up, buying a house becomes more expensive for most people.
So the recent rise in interest rates has John Mauldin on the Big Picture blog fretting that the Federal Reserve’s plan to buy Treasury bonds, called QE2, and presumably the tax deal as well, will make the struggling housing market that much worse.
QE2 and the nervousness of investors around the world are pushing up interest rates. We in the US may not have as much time as we think we do before Bang! and rates start moving up with a vengeance. And no amount of QE3-4-5 will bring rates down when the bond vigilantes strike fear into the markets.
Further, that money is not showing up in new loans to either consumers or businesses. It is showing up in asset prices like stocks, emerging markets, and commodities. Oil at $90 and gasoline at $3 per gallon is a tax on consumers, especially at the lower end of the scale. Food prices climb as grains explode, along with the metals that go into our products. And rising interest rates are not good for mortgages. QE2 is not helping consumers or the housing market.
So will the tax deal and QE2 sink the housing market? Probably not. Here’s the problem with Mauldin’s and others’ logic: Interest rates don’t really have that much effect on housing prices. Consider what has gone on in the past two years. Up until recently, the Fed has been driving down the rate on the 10-year Treasury bond. But has that boosted housing prices or sales? Nope. What’s more, housing price continued to rise in the mid-2000s even when interest rates were rising. The real thing that drives housing prices is jobs and access to credit. People buy houses when they get a new job and can get a loan. They don’t buy houses when they think there is a shot they will lose their current job. So if the tax deal is able to boost the job market, housing prices should rise. If not, prices will fall. The tax deal’s effect on interest rates doesn’t matter nearly as much, at least when it comes to housing.