Will The Fed's Interest Rate Hike Hit Homebuilders?

The Federal Reserve took the investor community by surprise when it announced Wednesday that the central bank intends to raise benchmark interest rates at some point this year as it believes that the U.S. economy is improving steadily.

Ever since the Fed ended its six-year long quantitative easing program in October last year and hinted at increasing the short-term fund rate in 2015, investors have been speculating about the timing of the planned interest rate hike.

However, the Fed claims to remain “patient” in determining when to finally raise the benchmark borrowing costs from zero for the first time since the 2008 financial crisis. In making the statement, the Fed said it would consider the sluggish economies of Asia and Europe before taking the final call. Moreover, low inflation and a strong dollar are the deterrents to a quick raise. Fed officials indicated that the first rate hike would happen around June.

What Does It Mean for Homebuilders?

A short-term fund rate hike would push mortgage interest rates up with it. It is predicted that the 30-year fixed mortgage rate will touch 5 percent by the end of 2015. According to the Freddie Mac mortgage survey, the 30-year fixed mortgage stood at 3.86 percent in Dec 2014.

High mortgage rates dilute demand for new homes, as mortgage loans become expensive. This lowers a buyer's purchasing power. This can hurt volumes, revenues and profits of the homebuilders.

This is perhaps the reason why housing stocks like PulteGroup, Inc. PHM, D.R. Horton, Inc. DHI, Toll Brothers Inc. TOL and KB Home KBH lost some value on Wednesday following the Fed's announcement.

Since mid-2012, homebuilders have largely benefited from historically low mortgage rates which led to a sharp increase in home buying. Though future rate hikes could dampen housing activity to some extent, the general market sentiment indicates that homebuilding activity will pick up in 2015 backed by improving job numbers and an upbeat economy.  Moreover, moderating home prices, higher rentals and a generally healthy supply of inventory are expected to pave the way for higher home demand this year.

Housing price gains slowed dramatically in 2014 and are expected to continue the trend in 2015. Moreover, analysts are predicting that millennials will start forming new households but with home prices rising, they will find it difficult to pay for a down payment which has grown larger. So instead of buying, they will rent and resultantly rents will keep rising too.

A big positive, however, is the lower fuel prices that have greatly increased the purchasing power of U.S. consumers. Backing it are the record employment levels. A reduction in fuel costs has given a fillip to consumer confidence, which in turn is expected to boost home buying

The positives also include President Obama's recently announced plans to cut premiums on mortgage insurance to encourage home buying among first-time homebuyers. This, coupled with an improving economy, will make homes affordable for entry level buyers and on the whole reinvigorate home sales up the value chain.

To Conclude

In case mortgage rates do rise in the latter half of this year, they should still be reasonable. Slightly higher rates notwithstanding, slowing housing price gains, easing credit availability, improving consumer confidence and better purchasing power amid an improving economy should keep the housing momentum going in 2015.

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PULTE GROUP ONC PHM: Free Stock Analysis Report
 
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