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Buyers Will Keep the Home Fires Burning

By Ryan Brecht Low mortgage rates have been the linchpin of the residential housing market in recent years, as the relentless downtrend in rates allowed a whole new crop of buyers to jump into the market. The sharp reversal in Treasury yields over the past month and a half has caused a rather dramatic rebound in mortgage rates, which has in turn generated a considerable amount of concern that one of the stoutest pillars of the economy is on the verge of crumbling.

The rise in interest rates is a potent source of risk to the residential housing sector, but borrowing costs need to be kept in perspective. According to Freddie Mac, mortgage rates are sitting almost one full percentage point above the 5.2% low seen in the middle of June.

Admittedly, this is a steep rise in financing costs over such a short period. However, when viewed with a broader perspective, rates are still quite lean. In the week ended Aug. 1, 30-year mortgage rates were just below 6.2%, which still ranks among the lowest rates of the past several decades. Moreover, the most dramatic action on the rate front in likely behind us, as the acceleration in Treasury yields was due to a confluence of factors that should not be repeated. As such, rates will likely drift higher through yearend on the back of solid economic growth.

PANIC SELLING? In addition to higher but still encouraging mortgage rates, a variety of other factors remain supportive of the housing sector. Despite soaring sales and prices, builders have been careful to avoid the overbuilding of residential dwellings that burdened the industry in the early 1990s. Supplies of new homes have averaged four months in the first half of this year, well below the most recent peak of 6.5 months in 1995 and the nine month supply in the early '90s. For existing homes, the 4.8-month supply is still lean when compared with the 6- to 7-month supply in 1997 and the almost 10 months seen early last decade.

On the demand side, an increasing population and a solid immigration rate should continue to support home sales. The structural constraints of the housing market will also help, as the costs associated with selling real estate and the regional nature of the market argue against a wave of panic selling in response to higher rates.

Against a backdrop of gradually higher rates, activity in the residential housing sector is expected to moderate in the second half. Home sales are pegged to decline in the third quarter after a solid second quarter. New home sales are expected to fall 2.7% in third quarter and a further 4% in the fourth quarter as this sector unwinds following a record clip in the second quarter.

REFINANCING DROP. Existing home sales are forecast to edge 0.5% lower in the third quarter but hold steady in the fourth. And housing starts -- a measure of new construction -- are expected to buck the trend, rising 2.7% in the third quarter and 1.2% in the fourth.

While the residential housing sector should be able to weather the squall of higher rates, the impact on the refinancing market has been swift, as activity has fallen sharply from record highs. This drop has generated a considerable amount of attention, given that homeowners' ability to convert equity into cash provided a crucial backbone to consumption over the past few years.

Given the recent backup in applications that are still awaiting processing, though, homeowners will continue to realize the spoils of refinancing in the third quarter despite higher rates. And while the refinancing impact will gradually fade as the year progress, improvement in the job market and income gains that come along with a better economy should more than offset the reduced stimulus from refinancings. Brecht is a senior economist for MMS International

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