Will the Fed Rate Hike Dent Housing Stocks in 2016?

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The Federal Reserve raised interest rates for the first time in more than eight years at its Dec 16 meeting - clearly indicating its rising confidence in the U.S. economy. The last federal fund rate hike happened in 2006. The Fed has kept interest rates near zero since Dec 2008.

The Fed increased its short-term borrowing rate to a range of 0.25% to 0.50% as policy makers unanimously voted in favor of a rate hike. Strong October/November employment numbers, declining unemployment rates and improving consumer confidence fueled the lift-off.

The Fed rate hike has assured investors that the U.S. economy is resilient enough to bear future increases in borrowing costs.

Fed Rate Hike & Homebuilding Stocks

Many have been concerned about the relationship between housing and interest rates and its impact on homebuilding companies like Lennar Corp. LEN , D.R. Horton, Inc. DHI , Toll Brothers, Inc. TOL , PulteGroup, Inc. PHM , Meritage Homes Corp. MTH , KB Home KBH , and many others.

A hike in the federal fund rate would probably push mortgage interest rates up with it. High mortgage rates dilute demand for new homes, as mortgage loans become expensive. This lowers a buyer's purchasing power and can hurt homebuilders' volumes, revenues and profits.

Mortgage rates, in tandem with interest rates, have been at historical lows since 2008. Homebuilders have largely benefited from these low mortgage rates that led to a sharp spike in home buying since 2012.

This has specifically been a good year for the housing market, possibly the best since 2007 when the housing recession had set in. In case mortgage rates rise with the interest rate hike, we believe they should still be reasonable, keeping housing affordable.

Moreover, the Fed has clearly emphasized that the pace of rate hike will be slow and gradual. Modest hikes in interest rates in the context of an improving economic environment can be a net positive for the housing sector. Stronger general economic conditions can encourage consumers to form new household, leading to higher housing demand.

In a nutshell, slightly higher rates notwithstanding, an improving economy, job and wage growth, improving consumer confidence, moderating home price gains, rising rentals, rapidly rising household formation and a limited supply of inventory should keep the housing market momentum alive in 2016.

A group of analysts believe that as the global economic situation deteriorates, U.S. mortgage rates might well nigh drop. As non-U.S. economies weaken, investors would park their funds in a much safer U.S. economy - a key factor which has been driving up the U.S. dollar for the past few months.

Meanwhile, mortgage rates are based on the price of mortgage-backed securities and such bonds are U.S. dollar-denominated. Therefore, when the U.S. dollar becomes strong, the value of mortgage bonds also rises. Rising prices for these mortgage bonds result in lower interest rates.

This explains the fall in mortgage rates this year. According to the Freddie Mac mortgage survey, the 30-year fixed mortgage was 3.94% in Nov 2015, less than 4% a year ago.

Even though the Fed has raised interest rates, there at least seems to be no sign of an immediate improvement in global economic health. This will keep mortgage rates relatively low. Homebuilders therefore need to fear little about the housing momentum losing steam in 2016.

However, labor shortages and rising land and labor costs can somewhat restrain homebuilders to adequately respond to rising demand next year. Apart from that, the U.S. homebuilding industry seems to be on a much firmer ground going into the New Year than they were this time last year.

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PULTE GROUP ONC (PHM): Free Stock Analysis Report

LENNAR CORP -A (LEN): Free Stock Analysis Report

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D R HORTON INC (DHI): Free Stock Analysis Report

MERITAGE HOMES (MTH): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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