Higher Mortgage Rates Slow Pace of Sales

For the first time since August 2004, sales of detached existing single family homes fell below 600,000 units. A year-to-year decrease was anticipated, because sales a year earlier had reached an all-time high. However, the decline was exacerbated by higher interest rates in October and November. Sales fell to 579,560 units in November, a 6.8 percent month-to-month decline from October 2005 sales of 621,530 homes, and a 11.2 percent year-to-year decline compared to November 2004 sales of 652,340 homes.

Supply indicators such as the unsold inventory index and median time on market have edged up in the last couple of months, also an indication that the market has entered the off-peak period. Home prices continued to behave as expected. The statewide median price rose 16.2 percent year-to-year from a November 2004 median of $471,980 to $548,400. This was consistent with expectations of a 16 percent increase in the median for all of 2005. The median price currently appears to be holding steady at an off-peak plateau in the neighborhood of $545,000, approximately $20,000 below the peak of $568,300 that was established in August 2005.

The rate on the 1-year adjustable rate mortgage (ARM) has been increasing steadily since the start of the year, beginning the year with at 4.12 percent in January and rising by just over 100 basis points to 5.14 percent in November. The rate on the fixed rate mortgage (FRM) had been on the rise since June 2005 when it reached a low of 5.58 percent for the year. It crossed the 6 percent threshold in October for the first time since mid-2004.

If rates stay at these levels, as is expected, they would still be low by just about any standard except that of recent history. Thus, sales will likely return to a fairly strong pace, albeit slightly below the record setting levels of 2004 and 2005. This will not become apparent until February at the earliest. All-time records for sales were established in December 2004 and January 2005 as well as November 2004, so sizable year-to-year declines in sales are expected over the next couple of months.

It is likely that there was forward shifting of some sales to the third quarter of 2005 in anticipation of these higher rates. There may also have been some postponement of activity as well, as would-be buyers moved to the sidelines and waited to see if rates would stay at these levels on a sustained basis.

The wild card in the near future is the psychological impact of higher rates on consumers. The Federal Reserve Bank is expected to increase the federal funds rate by another quarter point to 4.50 percent at its next meeting, putting it neck-and-neck with the yield on the 10-Year Treasury. This could create uncertainty for consumers, who have heard numerous times about how an inverted yield curve presages a recession. Many analysts have said otherwise, pointing out that the economy has good fundamentals, that inflation is in check, and that this trend suggests an alignment of inflation expectations between policy-established short-term interest rates and market-driven long-term rates.