Weekend Talking Points - 'Fifty'

An aggressive start to the Fed’s new easing cycle, with a 50 basis points rate cut announced on Wednesday.

Builder confidence rises. The NAHB’s builders’ confidence index rose 2 points to 41 in September, drive by a 4 point rise in the Future Expectations component to 53. What does this mean? That builders are overall still bearish (<50 = pessimistic), but hope is rising that sales will rebound thanks to the sharp drop in mortgage rates.

Retail sales flattish. With two-thirds of US GDP coming from private consumption, trends in retail sales are very important. In August, retail sales rose just 0.1% MoM, but that was actually a bit better than expectations.

Fed’s first cut is 50 basis points. On Wednesday, the Fed lowered its short-term policy rate by 50 bps (that’s 0.5% or a half a percentage point) from a range of 525–550 bps → 475–500 bps. In his press conference, Fed Chairman Jerome Powell tried his best to convince the market that: 1) the economy was still strong, 2) unemployment was still low, and 3) that the Fed wasn’t behind the curve. But if that’s all true, why start with 50 bps?

TP: Every other meeting, Fed members are asked to give their forecasts for things like GDP, the unemployment rate and the Fed Funds Rate. Based on their answers, the typical Fed member is looking for 50 bps more in rate cuts before year-end 2024, and an additional 100 bps in rate cuts over the course of 2025.

Nice bounce for new construction. In August, new home permits (+5% MoM), starts (+10%) and completions (+9%) all had a nice move. During COVID, we saw multifamily unit construction ramp to record levels. Well, those apartments and condos are now being delivered at a pace we haven’t seen since 1975! And 60% of those are being built in the South (which includes TX & FL). This could continue to put pressure on rental rates there. [Source: Census Bureau]

Lower rates not boosting existing home sales…yet. August existing home sales fell 2.5% MoM to a seasonally-adjusted, annualized rate of 3.86 million units. That’s the lowest figure we’ve seen since October 2023, which was when mortgage rates peaked above 8%!

TP: Why aren’t lower mortgage rates leading to more demand? First, remember that existing home sales captures contracts that were signed up to 1.5 months ago, when mortgage rates were much higher. Second, even when buyers get excited about lower rates, it takes time for them to find and close on a property. Third, home prices are still very high. Affordability remains an issue.

Realtors Are a Bit More Optimistic.

Similar story to last month: competitive ferocity is fading (always happens this type of year), and is definitely lower than the same time last year (fewer homes selling above list price, fewer offers per home sold). However, Realtors are more hopeful that buying activity will pick up over the next 3 months thanks to sharply lower mortgage rates.

% of Properties Sold Above List Price

Number of Offers per Home Sold

Percent of Respondents Expecting Rising Buyer Activity

Wait! The Fed Cut Rates and Mortgage Rates Went Up?

On the day of announcement, yes. But this sort of thing happens in the markets all the time. Let me explain, step by step:

• The Fed does NOT set mortgage rates. But the level (and direction) of the Fed Funds Rate influences mortgage rates (and pretty much every other debt instrument).
• Mortgage rates are determined by market forces — the prices/yields of US treasuries and mortgage backed securities, credit demand, competitive decisions made by the lenders themselves, etc.
• This means that mortgage rates can and do move well in advance of actual Fed rate decisions. Essentially, the bond market is ‘predicting’ where the Fed Funds Rate will go.
• Average mortgage rates (as measured by Mortgage News Daily), had already fallen from 7.43% at the end of April to 6.11% just prior to the Fed decision. That’s down 130 bps (1.3%) in a few months.
• Just prior to the Fed decision, the Fed Funds Futures market was already pricing in a high probability of a 50 bps cut on Sept 18, with 100 bps in rate cuts expected before the end of 2024.
• So market expectations for rate cuts were already very high. A lot of good news was already priced in. In this kind of situation, good (but expected) news can have a neutral or even negative impact on the markets — at least in the short term.

It’s important to understand this interplay between market expectations and the actual data delivery. This is also why a listed company can deliver 80% earnings growth in a quarter and have its stock get crushed. Why? Because the market was looking for 100% earnings growth!

In any case, I wouldn’t worry about what happened on the day too much. This first 50 bps rate cut is just the beginning of a ‘normalization process’ (Powell’s words) that could see the Fed Funds Rate drop an additional 150 bps (1.5%) from here through end-2025.

Mortgage Market

Here are the current odds on Fed rate cuts at upcoming FOMC meetings. Note that the Fed Funds Rate policy range AFTER the 50 bps cut is 4.75–5.00%.

• Nov 5: US presidential election.
• Nov 7: 58% probability of a 25 bps cut; 42% probability of a 50 bps cut.
• Dec 18: 49% probability that rates will be 75 bps below current levels.

They Said It

“Home sales were disappointing again in August, but the recent development of lower mortgage rates coupled with increasing inventory is a powerful combination that will provide the environment for sales to move higher in future months. The home-buying process, from the initial search to getting the house keys, typically takes several months.” — Lawrence Yun, NAR’s Chief Economist