As I was compiling the (very thin) June recap I was struck by how the prices of CME Case Shiller home price futures have continued to rise year after year.
Note how the year-end CME prices (as measured by mid-market) are higher in Dec ’12 than in Dec ’11, higher in Dec ’13 than Dec ’12, and so on. Today’s prices are also higher than year-end 2014.
I expect that some of this may be that futures markets might “need” continued reaffirmation of a strong market for home prices. That is, prices for the Nov ’18 contract may be somewhat based on the notion that past upward momentum will be maintained. Each monthly Case Shiller release -even if not a surprise- then gives bidders for longer-dated contracts more comfort to inch higher their bids.
While that may be – and needs feedback from academics who’ve observed such in other products – in addition there have been more surprises to the upside over recent contract expirations. That is, the actual Case Shiller release has been more likely to be above the bid/ask range of the contract that expired the day-before, than below.
Furthermore, Wall Street housing analysts seem to have also been surprised with the robustness in home prices and my sense is that more have revised their price forecasts higher over the last few years, than lower (with Chris Flanagan’s (BOA) call for lower prices after 2017 being the one exception that’s hit my radar).
So then, what has been the source of these surprises?
A debate over home price winners and losers prompted me to look at the tiered Case Shiller indices available on the S&P website. (Use the pull-down menu “Factsheet” ) While I’m sure that others have commented on this extensively elsewhere, I was struck by how much home price gains were concentrated in the bottom one-third of home prices.
The set of graphs to the left shows the month-on-month, and year-on-year percentage price differences in the non-seasonally adjusted tiered indices for the CUS 10-city index components. Two things jump out (and again treat this as my journal if already obvious to all):
- There is much more seasonality in the lowest 1/3rd group regardless of weather (e.g. cold in BOS, CHI vs. warmth in MIA, SFR) or relative level of home prices (e.g. CHI vs. SFR),and
- The lowest 1/3rd sector has been where the biggest gains have been over the last year (e.g. BOS, CHI, DEN, MIA, SFR and WDC).
The last few years have seen efforts to restart housing, declines in distressed sales (which I’d imagine are concentrated in bottom 1/3rd), the impact of rent-to-buy RTB programs (also concentrated in areas where home prices are more affordable), and “some” relaxation of underwriting standards (which might have a bigger impact on the marginal buyers that own – or want to own – homes in the lowest 1/3rd price group.
Net it shouldn’t be surprising that gains in the lowest 1/3rd priced homes have gotten here (i.e. can explain recent home price gains and surprises).
But what about going forward? I might not expect RTB programs to be as big buyers going forward and the level of distressed sales has reached levels from before the crash in home prices. Much has been written about how income gains have been concentrated in the top 1% (and are not reaching the likely buyers of the bottom 1/3rd-priced houses).
In addition, the age-old question of the impact of (possibly) higher mortgage rates was raised in a today’s HousingWire post . At today’s interest rates, small absolute increases in mortgage rates result in big percentage changes in monthly payments, and therefore affordability. While traders and investors might be able to stomach a 1% rise in mortgage rates, where will the borrowers for the bottom 1/3rd-priced homes come up with the extra cash?
Finally, if interest rates rise, what impact will that have, and how concentrated will that impact be, on those borrowers for the bottom 1/3rd-priced homes who have ARMs? (Has anyone got evidence -more than anecdotes -as to whether ARMS are concentrated in lowest 1/3rd home prices.) While the bond market may be focused on “one and done” rate increases from the Fed, what happens if the Fed gets behind, starts to focus on inflation and has to ramp up short rates dramatically? Even modest changes in short-term term (benchmark) interest rates could have a huge impact on homeowners ARM payments.
While I usually remain neutral on my views of forward home prices, the historical dependence of price gains in the lowest 1/3rd in home prices has me wondering about CME CUS 10-city futures prices for 2017-19. We’ve gotten here on the gains in lowest-priced homes. Can anyone argue that that is sustainable?
Anyway, I figured that I’d share the graphs, stir the pot, and hopefully get some discussion (and trading) started about price levels on longer-dated CME contracts.
Anyone with ideas is welcome to post here (or the LinkedIn group- CME Case Shiller Home Price Futures).
Also, please feel free to contact me (email@example.com) if you have any questions about this blog or any aspect of hedging home prices.