Will Rate Hike Crush Housing? 4 Stocks That Say No

As expected, the Federal Reserve hiked funds rate for the second time this year by a quarter percentage point to a range of 1.75% to 2%. Moreover, chances of two more rate hikes this year are high. The rate hike was imminent given the solid economic scenario backed by low unemployment and solid wage growth along with a rise in prices.

The unemployment rate fell to an 18-year low in May to 3.8% from the previous month. For the first time since 2000, the number of job openings now exceeds the number of workers to fill in the positions. Fed expects the rate of unemployment rate to be 3.6% this year, down from 3.8% expected earlier.

A tight labor market invariably leads to an increase in wages, with total wages up 2.7% in the last 12 months. Again, more income in the hands of individuals leads to increased demand for goods and services which in turn leads to higher prices. In the 12-month period through May, the Consumer Price Index (CPI) was up 2.8%, its biggest year-on-year rise since early 2012. The core CPI measure, which excludes volatile food and fuel costs, rose 2.2% from May 2017. Fed expects inflation to rise 2.1% for this year through 2020.

Therefore, to put a check on inflation, an interest hike was quite imperative. Though an increase in interest rates increases the cost of borrowing, Fed officials are confident that the economy won’t be affected by higher borrowing costs. The committee sees economic growth of 2.8% for 2018, highlighting an increase of 0.1 percentage point from the estimates issued in March 2018.

Impact of Rising Rates on Homebuilders

With two more hikes expected this year along with three in 2019, investors in the housing space are jittery. Shares of prominent homebuilders like D.R. Horton (NYSE:DHI) , Lennar Corporation (NYSE:LEN) , Toll Brothers (NYSE:TOL) lost around 4% while that of PulteGroup (NYSE:PHM) fell 6.7% and KB Home (NYSE:KBH) slipped about 7%.

A hike in the benchmark Federal Funds’ target rate will probably lead to a rise in mortgage rates in the remainder of 2018 or thereafter. High mortgage rates dilute demand for new homes as mortgage loans become expensive. This lowers the purchasing power of buyers and hurts volumes, revenues and profits of homebuilders.

Will This Lower Affordability?

The rise in interest rates comes at a time when home prices are increasing owing to supply constraints and increased raw materials costs. Builders are spooked by higher aluminum and steel costs, thanks to the newly-imposed tariffs. This coupled with increased lumber prices owing to an import tariff is denting builders’ margins, prompting them to bump up prices. Further, troubles like labor shortage and limited land availability continue to make things difficult.

Additionally, the rise in mortgage rates may impact affordability at a time when millennials are taking baby steps into the housing market. Higher interest rates will only flare up such issues but will also delay home purchases by millennials.

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Total mortgage applications fell 1.5% in the week ending Jun 8 as is evident from the latest Mortgage Bankers Association report. Purchase applications for new loans fell 2% from the previous week, while refinance applications plunged 2%.

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Written By: Zacks Investment Research