From the July 01, 2011 issue of Futures Magazine • Subscribe!

Treasuries up & economy down

Straw houses

The phrase "double-dip" made its way back into economic analysis in late spring as the S&P/Case-Shiller Housing Index dropped to 138.16 and took out the bottom recorded in April 2009 of 139.26 (see "Bottom dropping out"). With this came news that home prices nationally had retreated to levels last seen in 2002, and some markets falling even further.

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In most recessions, housing is one of the first areas to pick back up and begin contributing to GDP, but that hasn’t been the case this time. Dales says that two years into other recessions, residential investment or home building has contributed about 1% to annual GDP growth, but in the last two years it has contributed nothing. Obviously this recession is different as the bursting of a housing price bubble was the underlying cause.

Bernanke agrees that housing has been a drag on the recovery. "The housing sector typically plays an important role in economic recoveries; the depressed state of housing in the United States is a big reason that the current recovery is less vigorous than we would like," he said in his speech to the International Monetary Conference.

There is a glut of bank-owned homes and short sales on the market. "[Foreclosures] are hurting housing now because those are existing homes that need to be sold before new houses can be built," says Keith Springer, president of Springer Financial Advisors. "Without a housing industry, which is a huge part of our economy, it is going to be a drag on our economy for years to come."

In addition to foreclosures and short sales flooding the market, there is an unquantifiable amount of shadow inventory. "It is presumed that if there would be any sign of prices lifting or even stabilizing, then there are a lot of people out there who would want to go ahead and sell their house," says Spencer Patton, chief investment officer at Steel Vine Investments. "That kind of specter is really not going to be good for prices."

As a result, analysts expect housing prices to continue to fall at least through this year and possibly through part of next year. Demand isn’t expected to begin increasing until 2014-2015. "After the Great Depression, it took 19 years for housing prices to retrace to pre-depression levels. That’s where we are now," Patton says.

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One of the most supportive factors for housing has been the low interest rate environment and this especially was true once the 10-year U.S. Treasury bond dropped below 3% yield on June 1. "In a normal economy, that would spur the housing market. In this economy, it is not the price of borrowing that is holding back the housing market, it is the inability of people to get it," Dales says. He expects the Fed to keep its policy rate near zero for another couple years and sees the 10-year bond dropping to close to 2.5% yield by the end of the year.

Springer has comparable expectations, assuming there isn’t another round of quantitative easing around the corner. "You’re going to have slower growth because of lower government spending. Lower growth means lower inflation. You add in fiscal responsibility and you have low yields," he says. Springer expects to see 2.50%-2.75% on the 10-year and 3.50%-3.75% on the 30-year by the end of the year. On Treasury futures, that translates to the 129-00 to 130-00 area in the long bond and the 127-00 to 128-00 area in the 10-year, a multiyear high. Edmonds points out that the Fed has pushed back any possible tightening to help housing but cautions, "They can’t just keep rates down [forever]."

He acknowledges that Japan has kept their rates near zero for more than a decade but adds that more of Japan’s debt is held by domestic investors whereas U.S. debt is held by foreign countries. "Our risk is higher," Edmonds says.

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