The markets took another whirlwind ride Thursday after the Federal Reserve’s most outspoken hawk, James Bullard, warned about the pace of interest rate hikes. Bullard, the President of the St. Louis Fed, told America what I’ve explained for nine months…
The Fed is nowhere close to containing inflation. There is clearly more pain ahead.
Bullard warned that the Fed may need to move to 5% interest rates to fight against sustained inflation. Then he said… we could move all the way up to 7%…
What gives? And what should you worry about next week?
Real Estate Is Under Pressure
The Hill reported Thursday that the housing market is heading for a steep correction. The Fed’s efforts to fight inflation are pushing interest rates higher.
A person who bought a $500,000 house at a 3% interest rate in 2021 pays the same monthly mortgage payment — principal plus interest — as a person who bought a $337,000 house at a 7% interest rate. That’s a stunning development.
The problem for last year’s buyers is that housing prices are now coming down. We’ve witnessed a quick downturn in the number of homes under contract. And for September, monthly prices were down by 2.6% year over year… That’s a record.
The pandemic — and the Fed’s massive monetary support — distorted equity, housing and bond markets. Now, we’re seeing the other side of the rampant speculation, a growing work-from-home movement and shift in investor sentiment.
New construction for homes dropped 9% year over year in October. Meanwhile, building permits were off about 10% to just 1.5 million.
Most analysts continue to anticipate a decline in construction — all while builders keep cutting prices to entice new buyers with existing inventory. This could exacerbate an existing shortage of homes, paralyzing the market for the foreseeable future.
Naturally, the market would rely on a Fed pivot — a move to lower interest rates or an increase in the purchase of mortgage-backed securities. And some investors continue to bet that such an event is coming.
However, I want to point out two key things…
First, Fed leadership continues to tell the market that no pivot is coming. Even if it only raises rates 50 basis points in December, that will have a profound impact on borrowing, and will likely drive mortgage rates even higher.
Second, even when the Fed pivots, markets rarely bottom quickly. It can take up to one or two quarters for the market to find its bottom. The same goes for the housing sector.
Believe the Fed
I urge people to believe the Fed when officials explain that interest rates are going higher. Yes, the Fed has broken the Bank of Japan, the Bank of England and now the cryptocurrency market.
But there’s still a lot of pain ahead for the housing markets. I continue to look at the iShares U.S. Real Estate ETF (NYSE: IYR) as a viable place to speculate to the downside.*
There are other assets facing significant shock from higher interest rates and weaker housing prices…
Redfin Corp. (Nasdaq: RDFN) shares are now at $5 compared to their 52-week high of nearly $46. While shares saw a nice squeeze on Thursday, there remains ample downside on this company.
Shares have now popped more than 40% since hitting a 52-week low of $3.08. At some point, when momentum goes negative, traders can look for a push back lower. This is an unprofitable company that still trades at an elevated multiple, and it will likely continue to cut spending and workers in the year ahead.
Meanwhile, Zillow Group Inc. (Nasdaq: Z) has been pushing lower — almost 40% on the year. The combination of higher rates, lower prices and weak buying in housing is bad for yet another unprofitable technology company in the space.
I would take aim at both when the time comes.
Enjoy your day,
Garrett
