New-Home Sales Would Be Hurt Most If Fed Raises Rates

NEW YORK (TheStreet) -- Despite the focus on the labor market, it's the housing sector that could suffer the most if the Federal Reserve raises rates.

Sales of new single-family houses declined 2.4% in July from a month earlier, the Commerce Department said Monday. The disappointing figure brought down SPDR S&P Homebuilders (XHB) and iShares Dow Jones US Home Construction (ITB) .

The homebuilders' exchange-traded fund is comprised mostly of Bed, Bath & Beyond (BBBY) , Home Depot (HD) , Lowe's (LOW) , Restoration Hardware (RH) and Whirlpool (WHR) .

The home-construction ETF gives the most weight to D.R. Horton (DHI) , Lennar (LEN) , NVR (NVR) , PulteGroup (PHM) , and Toll Brothers (TOL) . XHB Price Chart
XHB Price data by YCharts

New-home sales broadly declined from 2005 to 2011, and although they have picked up since 2011, higher mortgage rates and lackluster wage growth have curtailed growth.

Mortgage rates began to fall in 2008 as a result of the Fed slashing short-term rates and pumping liquidity into the economy as a way to combat the financial crisis. Last year, the Fed announced it was looking to end its stimulus program, which prompted a spike in mortgage rates.

Since then, the 30-year mortgage rate has stabilized above 4%, causing the cost of home buying to jump. Meanwhile, lackluster U.S. wage growth has also held back home buying.

Fed Chair Janet Yellen addressed the issue of sluggish wage growth during her speech at Jackson Hole, Wyo., on Friday, citing "pent-up wage deflation."

Weak wage growth, increasing mortgage rates and a 13.6% increase in median new-home prices from July 2012 have dented the confidence of would-be home buyers.

The chart below highlights the relationship between new-home sales and the Fed funds rate. The two tend to hold a strong inverse relationship, where new-home sales rapidly increase as the Fed cuts short-term rates.

In the 1990s and early 2000s, new-home sales spiked to all-time highs as a mixture of falling lending standards and low rates fueled an expansion.

Since the financial crisis, however, new-home sales have failed to recover strongly, even as the Fed has kept rates at record lows.


Data provided by The Federal Reserve

As the economy and labor market gradually recover, home-buyer confidence hasn't kept pace. Based on historical analysis, if the Fed raises rates, new-home sales could see what little recovery it is experiencing wiped out, which would hurt stock prices of companies in the homebuilder and home-construction industries.

At the time of publication, the author held no positions in any of the stocks mentioned.

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This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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