The US housing market starts 2016 with a strong economy, low unemployment, improving wage growth, and very low mortgage rates: A recipe for strong sales and price increases.

The US Housing market is poised for a strong start in 2016. The underlying economy was strong enough for the federal reserve to start raising interest rates in December. Unemployment is low and wage growth is picking up, so more qualified borrowers are likely to become buyers in the days ahead. Further, with mortgage interest rates trending down toward record lows, the demand for housing as expressed in dollars borrowers can put toward a purchase is near record highs.

The conditions as described above will likely lead to robust sales and strong price increases this spring. So does that mean happy days are here again? Perhaps not.

Right now, the housing market is safely sheltered in the eye of an economic hurricane. The housing market faces two very strong potential future headwinds, and there is no way to avoid them both.

The bears roar again

When the federal reserve raised rates in December, it signaled the end of cheap money that supported numerous Ponzi schemes and inflated asset values in nearly every asset class. The anticipation of higher rates caused commodities to trend lower for the last few years, and the reality of higher rates caused stock and bond markets to crash earlier this year. However, I recently reported that the Collapsing stock market may spawn a huge rally in real estate because investors fled risky asset classes and bought both 10-year treasuries and mortgage-backed securities, driving mortgage rates lower.

The bears are loudly proclaiming the next Great Recession, but I’m not so sure. The stock market is not a reliable indicator of economic calamity, forecasting nine of the last five recessions. However, investors fear a recession, so they are investing accordingly. Investors are either right, or they are wrong, but in either case, the forces feeding the hurricane will turn against housing.

Scenario 1: The economy is heading into recession

Based on recent market action, investors currently believe the federal reserve actions stalled the economy, and we are heading into recession. I recently spoke with one market watcher who believes the federal reserve is laying the groundwork for negative interest rates to respond to the upcoming recession. Gold is rallying, and safe-haven bonds are very popular, which is why we are at near record low mortgage rates.

Let’s assume for a moment the investors driving current market action are correct and the economy is about to slip into a recession. If that happens, mortgage interest rates will remain low, but unemployment will increase, and wage growth will slow down again. Higher unemployment and weak wage growth will be a headwind to housing. If it get really bad, we could see more delinquencies and foreclosures again.

Scenario 2: The economy is better than investors currently believe

Let’s assume investors are wrong, the underlying economy is strong, and we don’t get a recession. At some point investors will collectively realize their mistake, probably as jobs and wage data comes in better than expected. If this happens, the people with jobs and rising income will provide strong demand for housing. However, if the economy does show resiliency, investors will quickly retreat from their safe-haven buying and move into riskier asset classes. The exodus from 10-year treasuries and mortgage-backed securities will push mortgage rates up, acting as a headwind to housing.

Many analysts would like to believe strong job and wage growth will overcome the increasing costs of mortgage debt. It won’t. The math simply doesn’t favor it. Each percentage point mortgage interest rates go up, wages must rise 12% to compensate. Strong wage growth would be 4%, not 12%. It would take three years of very strong wage growth just to compensate for 1% higher mortgage rates. The federal reserve liked the math when they needed lower rates to reflate the housing bubble, but the math makes raising mortgage rates very problematic.

A headwind either way

Notice that either scenario leads to strong headwind to housing. Right now, we are experiencing the low mortgage rates the forecast a recession without the unemployment and weak wage growth that typically accompany a recession. These two factors can’t remain in alignment for long. One of the two scenarios above will play out.

My guess is that the economy will perform far better than the bears expect. When investors realize this, we could see a sudden and dramatic rise in mortgage rates similar to the taper tantrum in mid-2013 when mortgage rates went from 3.5% to 4.5% in about six weeks. As some higher rate level, the market friction will prevent further mortgage rate hikes, but for now, we have the best of both worlds — a strong economy and low mortgage rates, so I anticipate housing may prosper in early 2016.

Sara Zervos, February 25, 2016

If you live in Coastal California, you don’t need national housing statistics to tell you that the housing market is in good shape – stick a “For Sale” sign in the yard and there are dozens of offers within a few days. If you are a seller or homeowner in the some of the less-than-hot spots, you can still take some comfort from the majority of indicators that suggest that the market is not only solid, but still improving.

There is no denying the current strength in the market. The question is whether or not this strength is sustainable. I don’t think it is.

Worries about the state of the economy and the stock market justifiably create some jitters. However, the factors that positively influence real estate, such as employment, interest rates, and low inventory, are likely to trump the detractors looking ahead into 2016. …

Unfortunately, strong unemployment and low mortgage rates won’t coexist for much longer. That’s the core problem.

So what has naysayers worried? The top worry is the overall economy. Fears over China’s slowdown and the crash in energy prices have caused stocks to falter and coincided with a lull in manufacturing. Since housing is tied to economic activity, analysts worry that the sector will follow suit. In addition, new, tighter credit regulations have likely slowed down mortgages on the margin. To avoid another housing credit bubble, officials have tried to make house lending a slower and more careful process. These regulations were likely sand in the gears of the market over the past few months. Finally, consumer confidence has slipped in last month’s data; likely due to the swings and plunges in the stock market. All else equal, since a more confident buyer translates into more sales and higher prices, this is negative news on the margin.

This is the kind of weak, glib analysis that pervades the financial media. All the buyer confidence in the world isn’t going to overcome the increasing costs of mortgage debt likely to accompany a strengthening economy.

That said, there are many positives underpinning the longer run housing story. The housing crisis that was the epicenter of the 2008 crisis has almost finished healing. The massive overhang of foreclosures has nearly cleared, and new foreclosures are back to a long run average. There is also less debt in the system, as distressed homeowners had to sell, and also since many have shifted to renting given tighter lending standards. With less leverage in the system, we can expect less turmoil induced by a cyclical slowdown in the economy. … Overall, the positive price and sales trends in the housing market look intact. Ongoing economic malaise could dent sentiment on the margin, but cheap financing along with solid employment should provide a deep underpinning to home sales and prices this year.

The positive forces working on the market now will buoy the market for at least part of this year. As I stated above, these conditions are unique and subject to change with the winds of the broader economy and the financial markets. Don’t be surprised if a sudden rise in mortgage rates spoils the party.

Nine-Year Anniversary

Saturday February 27, 2016 marked the nine-year anniversary of my first public post, I am IrvineRenter (Inventory Cholesterol). In the nine years that followed, I posted five to seven days a week without missing a weekday post. I’m looking forward to a 10-year anniversary next year.

Thanks for your continuing readership.

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