Rate Hikes and the Fed’s Goals

Finally, a 1/4% increase in Federal Funds rate. The immediate response from the banks was 1/4% hike in the prime rate to 3.5%.  This may have some effect on HELOCs.  Adjustable mortgages facing reset may also see some changes.  These minor adjustments should however have no direct impact on the real estate market.

As for the 30 year mortgage rate, so far the reaction has been nothing more than normal daily fluctuations.  Even if mortgage rates eventually settle at a 1/4% higher level, that is only $30 a month for a $200,000 mortgage, or $60 to $70 a month extra in household income to qualify for the same mortgage. A quarter point should not make much of a difference but what about half a percent or more?


ph mansionThis mansion in Pacific Heights, San Francisco was sold for a record price of $31 m. in 2015 – it netted its owners a $4 m. profit in less than two years. Reportedly no improvements were made to the property. SF is one of the regions in which bubble conditions are not merely noticeable, but are better described as “raging”.

Photo credit: Zilov / MLS


Richmond Fed president Lacker said that four rate hikes in 2016 would be considered gradual. Assuming that each hike amounts to a quarter percent and long rates move up in unison, we may see mortgage rates in the 5% range.  Is the real estate market strong enough to support that?

San Francisco Fed president Williams said that the Fed aims to keep the economy running hot in 2016 but will target a 3.25-3.5% federal funds rate for 2017.  He also opined that if a shock were to hit the economy and send it back to recession, the Fed would not hesitate to cut rates and perhaps buy more bonds.  Is that QE4?  At the same time, he acknowledges:


“We are still in a situation where most of our tools are fully employed. It’s like an army that’s got all of your forces out there, you don’t have a lot of reserves,” said Williams. “It’s hard to feel like, well, I’m feeling any kind of sense of victory or something.”


1-housing startsUS housing starts before, during and after the bubble era – click to enlarge.


Fed policy is data dependent, so Ms. Yellen has said repeatedly.  Is the real estate market part of this “data”?  Yellen has also repeatedly stated that real estate is recovering, if too slowly.  I am not sure how she defines recovery.  Is she hoping for double digit price appreciation and the crazy 2 million per year housing starts we have seen 10 years ago?

Once upon a time, there were private lenders, portfolio lenders, private label MBS, agency MBS and other miscellaneous sources for financing a real estate purchase.  Mortgage rates were determined by market supply/demand and only somewhat influenced by the short term rates the Fed controls.  That changed after the QE operations.  Housing is financed almost entirely by the agencies – Freddie, Fannie, VA and FHA.

Total mortgage debt outstanding for 1-4 single family residences, including non-agency debt, is $9.95 trillion.  The first QE program started in early 2009.  It took six years and three QE programs for the  Fed to accumulate $1.758 trillion in agency MBS.  For the entire calendar year, mortgage rates have held steady, fluctuating within a quarter percent of 4%.

During 2015, the Fed has purchased $338.4 billion of agency MBS.  These purchases are not additional purchases, they are replacing maturing bonds and pre-paid mortgages. If the Fed were to allow maturing or prepaid MBS to roll off the books without replacing them at the rate seen in 2015, it would take 5.2 years for the Fed’s balance sheet to unwind all QE-related MBS purchases.


2-MBS held by FedMortgage backed securities held by the Fed – since the end of “QE3”, the number has largely remained fixed, as the Fed continues to replace all maturing securities. If it didn’t do that, the US money supply would deflate – click to enlarge.


The Central Planning Dilemma

What real estate data will the Fed be looking at in the context of monetary policy decisions? Unfortunately for Ms. Yellen, her predecessors have dug a really deep hole for her. Starting with Greenspan, Fed policy has been to accommodate or to accommodate more (see chart below).  The real estate market has survived not by low rates, but by the continual lowering of rates.

The Fed, resp. Ms. Yellen have never mentioned a target for mortgage rates, but in theory they can try to park themselves at a specific bid/ask so as to exercise full control over mortgage rates. However, if mortgage rates increase and the Fed starts purchasing more MBS to counter the trend, it may trigger yet more selling and therefore push mortgage rates even higher.


3-conventional mortgage rate30 year conventional mortgage rate – oscillating around 4% in 2015 (current level: 3.94%) – click to enlarge.


The Fed may also be looking at the Case Shiller national index. Remove the sub-prime mania (the four years ending 2006) and the correction that followed, and the index now is rising above historical trend and at a faster pace than in the last 30 years.  Look at the steep rise in prices since 2012.  The market is screaming bubble.  Is that the green light to tighten monetary policy further?


4-Case-Shiller IndexS&P/ Case-Shiller national home price index – bubble and echo bubble – click to enlarge.


On the other hand, Corelogic reported that as of Q3 of 2015, 4.1 million or 8.1% of all mortgaged homes still have negative equity.   8.9 million homes have less than 20% equity. Also per Corelogic, 10.2% of all sales in October were of distressed properties.  That does not sound very healthy.  Should the Fed consider additional accommodation?

As a side note to this, the Mortgage Debt Forgiveness Act has been extended through 2016.  In other words, debt “forgiven” in a deficient sale will not be treated as income.  Those who have been in that miserable predicament for so many years, should get off their fanny and complete a short sale now. This may be their last chance.

There are so many things that are fundamentally wrong with the real estate market that I will leave most of them to future rants.  For now, I would like to point out that the market suffers from an acute supply and demand imbalance, both geographically and in terms of its mix.  All the demand in Silicon Valley is not going to help Texas, which may start to reflect the stress of the oil industry.

In high demand areas like coastal California, construction of low cost entry level housing is economically infeasible.  As an investor it is more important to understand that if the real estate market heads south, the Fed will do whatever it takes to save it, as if it actually knew how.

I will close the first post of the new year with three observations:


  1. The market cannot handle a 5% or higher mortgage rate.  Refinancing still accounts for over 60% of mortgage applications.  At 5% or above, the only refinancing business left would be the government’s HARP subsidies.  As for purchases, all stressed out first time buyers with high debt to income ratios and low down payments will be wiped out. Without the entry level, the trade up level is gone as well.
  2. The Fed is in control of the real estate on/off button, but I am not sure if the Fed or Ms. Yellen appreciate the precarious position they are in.  I agree with SF Fed president Williams that all Fed tools have already been fully employed and there is nothing left. Transparency invites front-running. If the MBS market moves up (rates up/bonds down) in anticipation of tapering or more rate hikes, the Fed may have no tools left to effectively counter the move.
  3. It is impossible to tell what policy makers will do, especially during an election year.  Voters will vote for wild unrealistic promises – the wilder, the better.  If real estate prices depreciate, resulting in rising defaults and foreclosures, there will be zero chance that any branch of government is going to advocate allowing the free market to correct previous excesses.



In conclusion, it appears the Fed cannot raise rates and the Fed cannot not raise rates either.  There are equally strong arguments for and against both steps [ed. note: this in fact a typical example for the central planning dilemma – the planners simply cannot know what the “correct” interest rate is].  Personally, I look forward to the trading opportunities the Fed’s actions will likely bring in 2016.


Charts by: St. Louis Federal Reserve Research


Image captions by PT



Emigrate While You Can... Learn More



Dear Readers!

It is that time of the year again – our semi-annual funding drive begins today. Give us a little hand in offsetting the costs of running this blog, as advertising revenue alone is insufficient. You can help us reach our modest funding goal by donating either via paypal or bitcoin. Those of you who have made a ton of money based on some of the things we have said in these pages (we actually made a few good calls lately!), please feel free to up your donations accordingly (we are sorry if you have followed one of our bad calls. This is of course your own fault). Other than that, we can only repeat that donations to this site are apt to secure many benefits. These range from sound sleep, to children including you in their songs, to the potential of obtaining privileges in the afterlife (the latter cannot be guaranteed, but it seems highly likely). As always, we are greatly honored by your readership and hope that our special mixture of entertainment and education is adding a little value to your life!


Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke


Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • 5-cotmmrangegc03Ganging Up on Gold
      So Far a Normal Correction In last week's update on the gold sector, we mentioned that there was a lot of negative sentiment detectable on an anecdotal basis. From a positioning perspective only the commitments of traders still appeared a bit stretched though, while from a technical perspective we felt that a pullback to the 200-day moving average in both gold and gold stocks shouldn't be regarded as anything but a normal - and in this case actually long overdue -...
  • gold_bullionGold Sector Correction – Where Do Things Stand?
      Sentiment and Positioning When we last discussed the gold sector correction (which had only just begun at the time), we mentioned we would update sentiment and positioning data on occasion. For a while, not much changed in these indicators, but as one would expect, last week's sharp sell-off did in fact move the needle a bit.   Gold - just as nice to look at as it always is, but slightly cheaper since last week. Photo via The Times Of India   The commitments of...
  • wryAustralian property bubble on a scale like no other
      Australian property bubble on a scale like no other Yesterday Citi produced a new index which pinned the Australian property bubble at 16 year highs:   Bubble trouble. Whether we label them bubbles, the Australian economy has experienced a series of developments that potentially could have the economy lurching from boom to bust and back. In recent years these have included:    the record run up in commodity prices and subsequent correction;  the associated...
  • "What if we don't change at all ... and something magical just happens?"Prepare for the Unthinkable
      Red Ink Growth and profits mask a variety of problems.  They hide business inefficiencies and the money suck of corporate adminis-trivia.  They also conceal unproductive staff.   The final career leap   But most of all growth and profits obscure the extreme value subtracting forces of bloated management teams.  During good times it is unclear what these smug fellows do.  During bad times it is lucidly clear that most of them ain’t worth a darn. When the...
  • andy-duncan-and-claudio-grassA Looming Banking Crisis – Is a Perfect Storm About to Hit?
      Andy Duncan Interviews Claudio Grass Andy Duncan of FinLingo.com has interviewed our friend Claudio Grass, managing director of Global Gold in Switzerland. Below is a transcript excerpting the main parts of the first section of the interview on the problems in the European banking system and what measures might be taken if push were to come to shove.   Andy Duncan of FinLingo.com (left) and Claudio Grass of Global Gold (right)   Andy Duncan: How do you see the...
  • spankinggoodtimeUS Stock Market - a Spanking May be on its Way
      Iffy Looking Charts The stock market has held up quite well this year in the face of numerous developments that are usually regarded as negative (from declining earnings, to the Brexit, to a US presidential election that leaves a lot to be desired, to put it mildly). Of course, the market is never driven by the news – it is exactly the other way around. It is the market that actually writes the news. It may finally be time for a spanking though.   Time for some old-fashioned...
  • www-usnewsLove him or Hate him: Trump is the Revolution Against the Establishment
      The U.S. Elections: The Latest Crack in the System The 2016 U.S. presidential elections are unprecedented: I don’t believe we have ever witnessed before a campaign year so toxic, so dangerously divisive and full of ad hominem attacks. Both camps have vilified the opposition and their followers, creating a schism in society. There has been no rational dialogue on the issues that truly concern the American public.   The schism Illustration by : M. C....
  • larry-1Meet Your New Stimulus Allocation Czar
      March Towards Midnight The march towards midnight is both stirring and foreboding.  Like a death row inmate sitting down to savor his last meal, a grim excitement greets the reality of impending doom.  Thoughts of imminent mortality haunt each bite.   Tic-toc, tic-toc...   As far as the economy’s concerned, there’s no stopping its march towards midnight.  The witching hour’s rapidly approaching.  We intend to savor each moment and make the best of...
  • chairman-tienanmen-square-beijingDonald is Right – The System is Rigged
      Scams and Flimflams BALTIMORE – For weeks, the top news headlines have been about politics. And politics has been all about the Republican Party candidate for president of the United States, Donald Trump.   Two very different elections...   The Establishment, the media, and most right-thinking people look around and sniff the air. Something stinks. And the smell, they say, is coming from that skunk, Trump. Meanwhile, Hillary, all greased up with expensive...
  • state_police_980_600_s_c1_t_c_0_0_1Are the Deep State’s Drones Coming for You?
      What’s Aleppo?   Look out kid Don’t matter what you did Walk on your tip toes Don’t try "No Doz" Better stay away from those That carry around a fire hose Keep a clean nose Watch the plain clothes You don’t need a weather man To know which way the wind blows – “Subterranean Homesick Blues,” Bob Dylan   The entrance to Baghdad's “Green Zone”. Photo credit: Karim Kadim / AP   DELRAY BEACH, Florida – Biggest foreign policy blunder...
  • speculatorInterview with Doug Casey
      Natalie Vein of BFI speaks with Doug Casey   Our friend Natalie Vein recently had the opportunity to conduct an extensive interview with Doug Casey for BFI, the  parent company of Global Gold. Based on his decades-long experience in investing and his many travels, he shares his views on the state of the world economy, his outlook on critical political developments in the US and in Europe, as well as his investment insights and his approach to gold, as part of a viable strategy for...
  • donald-trumpIs “The Donald” Finished?
      Too Late for Trump? BALTIMORE – We checked. We checked again. Nothing. Despite our recent open letter to him, the person not sending us an email was Donald J. Trump. But let’s check with the markets before we return to politics.   S&P 500 earnings growth rate as of Q1 – from bad to worse, but evidently no-one cares as long as the central bank confetti supply continues gushing- click to enlarge.   While the world’s attention is fixed on Mr. Trump, Mr....

Austrian Theory and Investment

Support Acting Man

Own physical gold and silver outside a bank




Realtime Charts


Gold in USD:

[Most Recent Quotes from www.kitco.com]



Gold in EUR:

[Most Recent Quotes from www.kitco.com]



Silver in USD:

[Most Recent Quotes from www.kitco.com]



Platinum in USD:

[Most Recent Quotes from www.kitco.com]



USD - Index:

[Most Recent USD from www.kitco.com]


THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Buy Silver Now!
Buy Gold Now!