KEY DATA: Starts: -3.7%; 1-Family: +0.1%; Permits: -1.8%; 1-Family: +0.9%/ IP: +0.7%; Manufacturing: +0.5%
IN A NUTSHELL: “Manufacturing continues to expand solidly, but the housing sector seems to be flattening.”
WHAT IT MEANS: With both short and long-term interest rates on the rise, it is time to look at the interest sensitive sectors to see if they will be sensitive to a rise in rates. Housing is the sector always highlighted when the argument is made that rising rates would slow growth. So, what is happening? It is not clear. Housing starts did fall in April, but the decline came from a drop in the always-volatile multi-family segment. Construction of single-family units was essentially flat. Between April 2017 and April 2018, starts were up over 10% and for the first five months of this year compared to last year, they are up over 9%, so it is hard to say that the sector is not doing well. Looking across the nation, there were sharp declines in housing starts in all regions except the South. As for the future, permit requests were also down, again due to a drop in multi-family segment. But the level of permits continues to run above starts, so builders will likely be using those permits in the near future.
The manufacturing sector is in great shape. Industrial production jumped in April as the three major components, Manufacturing, utilities and mining posted solid gains. On a monthly basis, manufacturing output has been up, down and all around over the past six months and over the year, it is up only moderately. While vehicle assembly rates moderated and that led to a slowing in related sectors such as metals. But there was a solid increase in the production of all types of business equipment, led by a surge computer output. It looks like the hoped-for increase in investment spending is happening. Rising prices are generating a large jump in energy production.
MARKETS AND FED POLICY IMPLICATIONS: How high can mortgage rates go without affecting home purchases and construction? Probably a lot higher than they are currently. In the 1980s, 30-year mortgage rates were around 10%, in the 1990s they were in the 8% range and in the 2000s the rate hovered around 6%, yet housing starts were about 25% higher in each of those periods than their current level. In other words, mortgage rates could move from the near 4.5% rate to 5.5% or 6% before we discern any measureable impact. A better indicator of housing starts is housing price appreciation. When prices rise, builders build, but when they fall, watch out. Of course, home prices are reflective of demand, which is driven by the condition of the economy and income, but we are talking about indicators, not explainers. Nevertheless, prices are up sharply so we should expect home construction to continue to increase, especially since economic growth should be solid over the next year. That is the point that investors should consider when they start to panic about rising interest rates. The Fed is tightening because the economy is solid and inflation is back to where it should be. Thus, short-term interest rates, which are still historically low, should be moving back to more normal levels. Longer-term rates are increasing because stronger growth is triggering the rise in inflation back to more normal levels, so long rates should be higher as well. The point is, “it’s the economy, stupid!” A strong economy means the economy, including the housing sector, can support inflation in 2s and mortgage rates around 6%. Historically low interest rates and inflation are not birthrights and until we stop believing that, we will continue to fear the normal. We shouldn’t.