Housing Defies the Skeptics, Again

June's record existing-home sales belies the bearish case; nonetheless, it isn't going away.
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June's tally of existing-home sales, released on Monday, provided no clue of a slowdown in the housing market. Far from it, sales and prices hit new record highs. However, that probably won't cool chatter that with long-term interest rates higher since the end of June, and seemingly poised to rise further, the end of the housing boom may be in sight.

For the time being, the housing market is still displaying both signs of strength and of rampant speculation. Sales of existing homes reached a new record high of 7.33 million in June, up 2.7% from 7.14 million in May. That's also way above the consensus forecast of decidedly cautious economists, who expected sales of 7.15 million.

The average sales price also rose to a new record of $219,000, up 14.7% year over year. That's the sharpest price increase since November 1980.

Part of the strength is still very much linked to demographics, as baby boomers seek to buy a home to retire in or buy a second home, according to Joel Naroff, president of Naroff Economics. Beyond that "after first thinking that prices couldn't be sustained, all the stragglers are now getting in," he says.

There was a large gain in single-family home sales, which rose 22.4% on an annualized basis in the second quarter. But the most impressive gain was seen in the co-ops/condos category, which saw sales rise 38.8% on an annualized basis in the quarter. That's the one aspect that's "a little bit striking" in the June data, according to Wachovia economist Jason Schenker.

Co-ops and condos, he says, are becoming more attractive for speculators even as long-term interest rates start to rise. While rising long-term rates may discourage single-family home purchases, co-ops and condos, where mortgage costs are shared with other owners, are a different story.

"They become more attractive as investments, as rentals," Schenker says. "If rates rise, there's an incentive to seek cash flow."

The trend toward more speculation in the co-op/condo arena and some cooling in demand for single-family homes may become the story for months to come, as long-term interest rates seem poised to continue rising.

Toward the end of June, the yield of the benchmark 10-year Treasury bond, which is used to set mortgage rates, started to rise from around 3.90% to 4.24% as of midday Monday.

The impact on mortgage rates is already being felt. Home-mortgage rates rose to their highest level in almost three years last week, according to housing-financing agency

Freddie Mac

(FRE)

.

Arguably, rates remain relatively low and everything will depend on how high Treasury yields rise, and how fast. But further gains in yields are indeed expected. China's first step toward revaluating its currency last week fueled expectations that the Chinese central bank will purchase less Treasuries. Inflationary pressures may also be rising as a result, potentially putting more pressure on long-term yields.

Some economists believe the Chinese move could spell the end of what

Federal Reserve

Chairman Alan Greenspan had called a conundrum -- long-term rates remaining low in spite of the Fed's sustained campaign to raise short-term rates. In his semiannual testimony to Congress last week, Greenspan signaled the Fed would continue lifting short-term rates for the foreseeable future.

Merrill Lynch chief economist David Rosenberg now believes the Fed will lift its key fed funds rate to 4% by year-end, from his previous forecast of 3.5%. Greenspan clearly has the "frothy" housing market in his crosshairs, Rosenberg believes.

Economists, including Wachovia's Schenker and Joel Naroff, believe that 10-year yields at 5% to 6% can start cooling the market.

"It would cause it to stagnate but it wouldn't stop in its tracks," Schenker says. "When and how fast we get there, that's the big question."

A sudden, sharp rise in interest rates could squeeze out speculators from the market and create a snowball effect. With China's revaluation of the yuan potentially becoming one of the key drivers of U.S. rates, much will therefore depend on how quickly Chinese monetary authorities let the currency appreciate. So far, it appears this will be a long, drawn-out process.

On Monday, Li Deshui, a member of the central bank's monetary committee, told reporters that China won't make the yuan fully convertible for at least five years because it worries that hedge funds may force the yuan to plunge.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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