Issue 24 - March 9, 2005


Housing: Priority Number One for the Federal Reserve

Federal Chairman Alan Greenspan concluded two days of Congressional testimony last week. While his discussions focused on the long-term explosive nature of Social Security and Medicare liabilities as well as the current budget deficit, concern surrounding the U.S. housing market dominated his rhetoric and will likely dominate his near-term policy decisions.

The importance of the housing market cannot be underestimated – more than 70% of U.S. households own their own home. The repercussions of a housing bust could dwarf the impact of the 2000 equity market collapse (particularly given that the housing market was the major shock absorber cushioning that blow). As we wrote in our November 4th newsletter, the U.S. savings rate has declined to near zero in the past decade as consumers have replaced traditional bank savings with a variety of asset-based investments, including real estate. The challenge for the Fed Chairman will be to reign in this real estate market “exuberance” before his term ends in February 2006.

Calling the Top Again

Pundits have been calling the top of the housing market for several years now.
While certain residential markets can certainly be described as vulnerable, it is important to remember that an expensive home is not the same thing as an expensive stock. There are no regulatory specific margin calls on homes so long as the borrower is current on their loan and taxes, for example.

Housing prices are a function of interest rates and incomes. To upset the entire U.S. housing market would require a catastrophic collapse in personal incomes with a concurrent spike in interest rates. Though we expect interest rates to rise, many home mortgages are fixed rate and incomes remain strong, so the underlying health of this market is in reasonable shape.

Policy Implications

The behavior of our housing market is by no means unique in the world. In fact, the rate of change in our real estate market pales in comparison to markets such as the U.K. or Australia. Policy makers in both of these countries have recently been able to cool down demand for housing stock by raising short-term rates to a point that dampened demand. By raising rates, these countries made it prohibitively expensive for would-be first-time buyers to buy rather than rent. A market with fewer buyers does not translate to a collapsing market, but it likely translates to a market growing at a slower rate. We expect that is what our Fed Chairman would like to see happen here before the expiration of his term.

If this thesis is correct then we should expect the Fed to gravitate to the high side of current expectations and allow the Funds rate to rise to 4% or more. With current short term rates at 2.50% and 7 remaining FOMC meeting this year, it is clearly possible for the Fed to reach 4% while continuing along their path of quarter point increases at each meeting.

A 4% Funds environment would pose some challenges for the bond market. Bond bulls continue to comfort themselves with the certain knowledge that the Fed is almost finished with their work of normalizing the short end of the curve. When the 4% level is reached, the market should be well positioned and able to perform along with the growing economy.


In this Edition

  • Housing: Priority Number One for the Federal Reserve
  • Calling the Top Again
  • Policy Implications

Huntington Steele

925 4th Avenue
Suite 3700
Seattle, WA 98104



Past Issues

23 - 02.11.05
Interest Rates and the Federal Reserve
A New Demand Paradigm
No-Traditional Buyers
4% Looks Good
Chicken & Egg Market

22 - 12.02.04
Drooping Dollar
Not Everyone is an Investor
Implications for 2005
Putting the Euro in Perspective

21 - 11.04.04
Personal Savings
Absence of Rising Tide
US Elections

20 - 10.01.04
Coming or Going?
Speed Limit
Bond Market Showdown
Absence of Context

19 - 09.03.04
Aug '04/ Oil & Jobs/
Cooling of Hot Economy

18 - 08.03.04
July: A Difficult Stage

17 - 07.01.04
2004 Second Half Outlook

16 - 06.01.04
Big Bad Fed

15 -05.04.04
Rising Rates/ Google IPO

14 -04.01.04
First Quarter 2004

13 - 03.02.04
2004: Encore Performance

12 - 02.03.04
Market Outlook/Cell phones

More Past Issues
can be found in our

Newsletter Archive


Market Highlights

  02/28/05 01/31/05 12/31/04 12/31/03
DJIA US 10766.2 10489.9 10783 10453.9
S&P 500 US 1203.60 1181.27 1211.92 1111.92
Nasdaq US 2051.72 2062.41 2175.44 2003.39
EAFE Int'l Equity 1548.60 1486.97 1515.48 1288.77
5 Yr Treasury 4.043 3.723 3.649 3.231
5 Yr AAA Muni 2.93 2.85 2.79 2.45
10 Yr Treasury 4.4 4.158 4.257 4.225
10 Yr AAA Muni 3.63 3.55 3.64 3.6
30 Yr Treasury 4.697 4.561 4.817 5.01
30 Yr AAA Muni 4.48 4.40 4.58 4.54
EUR Currency 1.3259 1.3003 1.3652 1.2612
JPY Currency 104.35 103.63 102.48 106.92
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