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Housing braces for looming QE3 tapering consequences

Interest rates, tighter credit will hamper recovery

All signs are pointing to a new 'normal" in housing as fiscal drag continues to wane and a rebound in business investment spurs growth.

However, there is one risk that could turn the housing upswing on its side, the reduction in the Federal Reserve’s asset purchases, argued Fannie Mae chief economist Doug Duncan.

The uncertainty and eventual tapering of the central bank’s bond-buying program is likely to put additional upward pressure on interest rates and lead to some volatility in capital markets.

"Although the nature and timing of the tapering are still to be determined, we continue to expect the Fed will scale back its asset purchases and end the program by spring," Duncan stated.

The Fed has been signaling their intention to alter its open-ended third round of quantitative easing by slowing purchases later this year. And while the market awaits details — such as timing — investors remain on edge.

Nonetheless, the majority of the market expects an announcement at the September Federal Open Market Committee meeting that the central bank will begin to scale back asset purchases.

Royal Bank of Scotland (RBS) Markets & International Banking analyst Sarah Hu agrees that the biggest risk the housing market faces is the wind down of QE3.

"I think higher mortgage rates will raise borrowing costs, making home purchases and refinances less affordable," Hu said.

She continued, "But we could still see lending standards ease to counterbalance the impact of the increased mortgage rates, perhaps to some extent."

On a similar note, Capital Economics property economist Paul Diggle believes higher mortgage interest rates are one threat to the housing recovery.

"However, we think that mortgage rates are unlikely to increase sharply from here. In fact, our end-year forecast for 30-year rates is 4.5%, rising to 5% at the end of 2014," Diggle noted.

He added, "In that scenario, rates are not going to take much of a toll on affordability. Rates will still be fairly low in an historical context."

The property economist believes bigger threats to the housing recovery are the very sharp rise in home prices, which is doing more to reduce affordability than higher mortgage prices.

Additionally, higher prices are undermining investment incentives, which is causing investors to exit the market.

New home sales jumped in June for the third consecutive month as inventory gradually trended up after reaching its trough in July.

However, the number of completed new homes for sale remained at a record low.

For instance, the inventory of new homes fell to a 3.9-month supply, matching levels reached earlier this year when the market reached its lowest reading since mid-2004, Fannie Mae said.

Another risk to the housing recovery is the continued tightening of mortgage credit.

"Credit needs to loosen before more conventional, mortgage-dependent sources of demand can return in greater numbers," Diggle said.

Regardless, Duncan and other Fannie Mae economists expect the positive fundamentals of housing demand will offset the impact of rising interest rates, helping to support activity during the rest of the year and produce increases in sales and starts for all of 2013.

"We expect that historically tight supply conditions will continue to support further home price gains. While the number of new and existing homes available for sale has risen over the past year, it has remained lean by historical standards," Duncan concluded. 

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