For the past five years, the government has been pumping billions of dollars into the U.S. economy via the Federal Reserve Bank's "quantitative easing" (QE) program while simultaneously forcing short term interest rates down to near zero percent. All of this was designed to spur economic growth - particularly in the housing market. Did it work? Mortgage rates (30 year fixed) fell to near three percent but all we heard were stories about a backlog of homes for sale and no buyers. All of a sudden, the market did a "180" this summer and TV ads by real estate brokers and mortgage lenders declared that buyers are back in the market and there is a shortage of homes for sale. What happened?
Traditionally, the common wisdom is that lower interest rates stimulate economic activity and higher rates impede growth. Apparently, we live in a different world now. With the Fed rigging the interest rate market, potential home buyers remained comfortably on the sidelines waiting for further declines in home prices. Then, this spring, Fed Chairman Ben Bernanke merely hinted that the Federal Open Market Committee (FOMC), may consider scaling back its QE bond buying program. The reaction: interest rate futures markets - the largest of all the commodity markets in terms of volume and open interest - quickly sold off and adjusted to what it perceived as a new rate environment. Subsequently, mortgage rates began rising and the yield curve (rates by maturity) steepened in anticipation of higher future rates. A death knell for the struggling housing market? Quite the opposite. Pent up demand for real estate complacently sitting on the sidelines suddenly realized that the interest rate cost of buying a home may be going up - at least to free market equilibrium levels.
The chart (above) illustrates the phenomenon of rising rates turning the housing market around. Buyers did not want to miss what will probably be a once-in-a-lifetime opportunity: bargain basement prices for real estate and record low mortgage rates. Is there a lesson here for Keynesian economists? Perhaps excessive central bank market manipulation is not good monetary policy. Regardless of the meaning, it was good to see some life return to the futures interest rate markets because, as one pit trader said, "when it's quiet in here, it's quiet out there."