Mortgage rates down! Housing still falling!

Home sales are dropping like a toppled redwood. Consider the latest numbers …

In July, sales of existing homes declined 4.1% from a month earlier. That was more than TRIPLE the Wall Street forecast. And they were down even more if you compare them to July 2005 — down a whopping 11.2%!

Sales of new homes were even worse: they dropped 4.3% from June and an astounding 22% year over year.

Since early July, though, mortgage rates have generally been falling. So things are getting better, right? Actually, no!

This is very perplexing to many people. It’s kind of like the age-old question, “If a tree falls in the forest and no one is there to hear it, does it make a sound?”

Only in this case, the question is: “If mortgage rates fall and home buyers aren’t paying attention, will the housing market continue to make a crashing sound?”

Home Sales Are Terrible,
Despite Lower Mortgage Rates

Take a look at the following table. It shows that 30-year fixed mortgage rates have declined from a recent peak of 6.86% to 6.31%. That’s a drop of more than half a percentage point.

And the average rate on a 1-year adjustable-rate mortgage has slipped almost the same amount from its early July peak.

	30-Yr. Fixed Rate	1-Yr. ARM Rate	MBAA Purchase Index
Recent Peak (Date)	6.86% (6/23)	6.41% (7/7)	425 (7/7)
Rate/level on 9/1	6.31%	5.91%	389.7
Point Decline through 9/1	55	50	35.3
Source: Mortgage Bankers Association

You’d think home buyers would be jumping at the opportunity to lock in a lower rate. No such luck!

Check out the Mortgage Bankers Association’s purchase mortgage application index. This is a key, real-time gauge of how many borrowers are applying for mortgages to buy a new home.

You’ll see that the MBAA index keeps falling despite the drop in mortgage rates.

All else being equal, it should rise by roughly the same amount that rates have fallen. Talk about a housing market riddle!

This is extremely unusual. What the heck is going on? Here’s my take …

Core Demand for Housing Is
Much Lower Than People Realize

In normal times, people buy homes to live in. This core demand depends on interest rate levels, wage and job trends, immigration, household formation, and more.

But in recent years, the Federal Reserve Board’s extreme easy money policy artificially drove the demand for housing (and thus, mortgages) through the roof. Indeed, the Fed encouraged a wave of real estate speculation the likes of which we have never seen before in this country.

Case in point: A whopping 40% of the houses bought last year were purchased as second homes or investment properties, not primary homes. According to the National Association of Realtors, that was the highest percentage of non-owner-occupied purchases ever!

Now, those speculators are gone. If anything, they’re trying to sell, not buy. And vacation property buyers are also second-guessing the wisdom of taking the plunge in this environment.

Home sales are slipping, home inventories are skyrocketing, and home prices are slumping. Why buy a “luxury” property if you’re not going to be able to sell it later for a tidy gain?

Result: All that extra, artificial demand for mortgage financing is gone.

Moreover, the “real-estate-can’t-lose” bubble psychology is rapidly morphing into a different line of thinking that goes something like this:

“Hmmm … maybe buying ten money-losing rental homes in the 110-degree Arizona desert isn’t such a great idea after all.”

In the simplest terms — the biggest residential real estate bubble in U.S. history has burst. Can somewhat lower interest rates REALLY re-inflate it? They sure haven’t yet …

Lower Rates Will
Not Solve Everything

Look, we have 3.86 million existing homes on the market. That’s the most in history. We’re also sitting on an all-time record supply of 568,000 new houses. This is a monumental supply glut. And as I told you a moment ago, sales are falling at double-digit rates.

That’s not the only bad news: The Office of Federal Housing Enterprise Oversight just reported that quarterly home price growth plunged to 1.17% in the second quarter from 3.65% a year ago. That’s the sharpest decline the agency has ever seen, and it’s been tracking the market for more than 30 years!

Next, brace yourself for outright declines (not just slowdowns) … in home prices nationally (not just regionally)!

I know Wall Street wants to just wish this away, but I’d rather focus on the cold, hard evidence.

And so far, everything suggests that lower rates aren’t doing a darn thing for housing demand.

The biggest question of all: If lower rates aren’t going to save housing, how much worse would higher rates make the situation?

Right now, not many people are talking about higher rates. But I see something on the horizon that’s troubling …

An Important Warning
For All Investors

Mortgage rates are tied to bond yields, and I’m seeing signs of a potentially big problem in the bond market:

A whole bunch of people are loaded up with Treasury futures right now. In other words, they’re betting heavily that interest rates will continue to come down, driving bond prices higher.

These speculators had a whopping “net long” position in 10-year Treasury note futures of 430,530 contracts. That’s the highest in at least 15 years by a wide, wide margin.

All this action is from the hot money guys, who typically use big leverage to profit from small moves in the price of Treasury notes and bonds.

The fact that this huge imbalance exists is worrisome because it could set off some unwanted fireworks:

If anything — anything — upsets the bond market apple cart, we could see a major sell-off in bonds. All these bettors would be rushing for the exits at the same time. That would push prices even lower and interest rates even higher.

Some potential catalysts? It could be bad inflation news. It could be foreign investors selling their dollars.

Bottom line: Given the situation, I’d be very concerned if I owned a boatload of 30-year Treasury bonds. And I’d be even more concerned if I were swimming in a sea of leveraged real estate properties.

Until next time,

Mike

P.S. You don’t have to just sit and watch these major bombs go off in the interest rate, housing, and mortgage markets. If you want to learn how to potentially profit from them, consider my Interest Rate & Currency Trader service. For more details, give my friends in customer service a call at 1-800-815-2917.

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