Yesterday was an interesting day for anyone involved with real estate.  Whether you’re a Realtor, mortgage broker, buyer or seller, the events of May 28 were pretty incredible.  As is the story on the last Tuesday of every month, the S & P Case-Shiller housing index numbers were published.  They showed what anyone buying or selling a home already knows, that prices are up and up substantially from a year ago. The report attributes these gains to an improving economy and a shortage of available inventory.  Duh, right?  They go on to say that their Statistical Averages posted the single largest gains since the housing boom.  This in turn did what?  It caused bond traders to dump long term bonds and rates went up the most in one day since 2010.

Bonds are funny things and when the price of a bond goes down its yield goes up.  So for example say a bond is valued at $100 with an interest rate of 4%, the yield is 4% (4/100 = 4).  But let’s say the traders don’t want to buy them at $100 and only want to pay $90 for a 4% bond (4/90 = 4.4) or 4.4%.  To repeat, as the price of the bond drops, the yield goes up.  In this example the price dropped 10% from $100 to $90 and the rate went up 10% from 4% to 4.4%.  So when the price goes down, the rate goes up.  And what are mortgage interest rates tied to?  The 10 year bond.  Thus yesterday bond traders dumped bonds, in essence wanting a higher yield or rate than they were getting on the 10 year bond and the effect of that drop in price was to make mortgage interest rates go higher.

It is a common misconception that higher rates means a drop in housing values.  To understand this and further, what yesterday’s numbers portend, you have to understand why interest rates rise and fall.  The Federal Reserve sets monetary policy as a tool to manage inflation and the nation’s economic growth.  Too much inflation everyone agrees is a bad thing because as products cost more, we can buy less with the same amount of money.   When the costs of all goods goes up, so does housing.  But a little inflation is a good thing.  Rates rise when the economy is doing better and drop like they’ve been when the economy needs help and it’s the Fed’s job to manage that relationship between interest rates, inflation and the health of the U.S. economy.  Simply put, when the economy needs help, rates come down when it is stronger, rates rise.  Yesterday’s rise was the bond trader’s response to the perceived health of the economy.  Because bond traders deal with long term rates, they have to try to anticipate the Federal Reserve’s response to an improving or declining economy.  Getting back to rising rates and home values, rates rise with inflation and so do home values.  Homes are not somehow excluded when the price of all goods and services rise, they rise too.  So rising rates don’t necessarily mean declining home values.

As to the Fed… they continue to believe that the economy remains fragile.  Thus they are still buying bonds and lots of them, which keeps demand for those bonds is high and when demand for anything is high, the price goes up; when bond prices go up, the yield… goes down.  So yesterday the price of bonds dropped and the yield went higher but the Fed is still buying so the rise is most likely a knee jerk response to some positive economic data.

When bond traders are predicting a continued improving U.S. economy and that the Fed will eventually raise rates, they sell.  But is that a bad thing?  If you are buying a home using conventional financing, the cost of the home just went up as your borrowing costs went up, so yes, that’s a bad thing in the short term.  However, if the health of the economy is improving, isn’t that a good thing?  The answer is a resounding yes.  We have been hearing that the rise in home values has been disconnected with wages.  That wages have been declining with stubborn unemployment and people needing work are willing to do a job for less than what they used to.  But when the economy improves, unemployment drops.  When housing improves, builders begin building and hiring and those people in turn spend money which leads to more hiring and unemployment drops a lot.  Home building is and always will be, the engine that drives the economy.  And with prices of homes rising, you can bet that builders are going to build.  When I was growing up there used to be a cement mixing company and on the side of their trucks was the phrase, “Find a whole and fill it.”  That’s what builders are going to do to address the shortage of available home inventory, they will build and that means they will hire.  And what happens when hiring picks up?  Demand for skilled workers becomes more competitive and wages rise, thus everyone makes more money.

In the end, yesterday’s housing data tells us this: home values are going up and the economy as predicted by the bond trading community is getting better, and we will all be better for it.