Tuesday, April 7, 2015

The Treasury/Housing trade

I may be jumping the gun a little bit, but I think it looks like it is time to take a position on the treasuries/housing trade.  My thesis is that there is a large disequilibrium in the fixed income market.  Implied returns on houses and cyclically adjusted very long term real interest rates generally rose and fell together until 2007, when tight monetary policy caused a collapse in the housing credit market.  Since then, fixed income savings has been forced into treasuries, because of a lack of access to the real estate market, due to a stagnant mortgage market and market frictions that prevent investors from immediately making up for the lack of owner-occupiers in the single family home market.  The drop in total real estate holdings below trend is much more severe than any movement in the 2000s above trend.

A recovery in the mortgage market should allow savings to flow more readily into housing.  This should allow treasuries and residential real estate to coalesce back at an equilibrium relationship.  This means that home values should rise and treasury yields should also rise.

I don't know where the new balance will be.  This is not a hedged position.  If the economy falters before recovery is established, both of these positions will fail.  I don't believe that the policy interest rate is the bottleneck to the productive economy right now, though.  I believe mortgage credit is.  As long as the banks continue to expand mortgage credit, I believe the Fed would need to raise rates significantly in order to damage the coming recovery.  The key is expanding mortgages.

The point of taking the dual position (long housing, short treasuries) is so that I don't need to know the balance.  If long term real interest rates don't rise very much, the gains from this position will come mostly from the housing position.  If long term real interest rates rise more, then home prices will rise less, but the short treasury position will gain.

Mortgage growth appears to just be beginning at commercial banks.  Forward risk free interest rates have pulled back to new lows.  And, the employment market continues to look strong.  Job openings and quits continue to grow, even though hiring has leveled off in the past few months.  And, employment flows all continue to normalize, with strong flows back into the labor force.

Along with the new rise in mortgage levels, it looks like home price growth might be starting to move again.  I am counting on this new kink up in price appreciation to be persistent.

There might be several ways to capture exposure to residential housing.  I am not sure if any are better than taking an out-of-the-money option position on marginal, leveraged homebuilders.  Possibly the Case-Shiller Index would be a way.  And, there are many REITS of various types to choose from.

Note that unlike some economics bloggers, I am frequently devastatingly wrong.  Mileage may vary.


  1. Excellent blogging.
    I sense that property is a long-term buy as long as global incomes rise. In particular property in cities where wealthy people congregate or where the lifestyle is pleasant.
    for people of my generation this may look like a bubble. To people in 30 years, it will have looked like a buying opportunity.

  2. Thanks. Remember, though, homes are more of a fixed income investment. For a diversified basket of real estate, it's more about the income than the capital gains.