Dec 18 turned out to be a great day for homebuilders. Shares of top homebuilding companies rose on Wednesday after the Federal Reserve promised to keep interest rates low for some time despite its plans to start tapering its stimulus plan from January. The Fed will cut down its current $85 billion a month bond buying program by $10 billion to $75 billion.
The Fed was until now buying $85 billion in government bonds and mortgage backed securities every month, known as quantitative easing, to keep interest rates low and boost economic growth. In July, Fed chief delayed tapering of the bond purchases to keep interest rates low for some more time.
Since then, some investors have been expecting a reduction in the economic stimulus program before year end. Fed Chairman Ben Bernanke and company stated that the slowly improving economy and the lowered unemployment levels were responsible for the decision to start scaling down the bond buyback program. The U.S. unemployment rate fell to a five-year low at 7% in November.
Ideally, tapering of the bond-buying plan would have led to adoption of a tighter monetary policy, which would have increased interest rates further. However, Fed said that the federal funds rates (benchmark interest rates) will be kept low for even longer than previously promised, irrespective of the reduction in the bond buying program.
Stocks of large homebuilders like D.R. Horton, Inc. (DHI - Free Report) , Lennar Corporation (LEN - Free Report) and Toll Brothers (TOL - Free Report) as well as smaller ones like The Ryland Group, Inc. , Meritage Homes Corporation (MTH - Free Report) , KB Home (KBH - Free Report) and MDC Holdings Inc. (MDC - Free Report) rose on the Fed’s decision to keep interest rates low. Prices of these companies rose in the range of 3%-7% as homebuilding stocks are most sensitive to the outlook of interest rates.
High interest rates dilute demand for new homes, as mortgage loans become expensive; thus lowering a buyer’s purchasing power. This can hurt volumes, revenues and profits of homebuilders. Homebuilders have largely benefited from historically low interest rates, eventually leading to the sharp increase in home buying activity since mid-2012.
However, since May, mortgage/interest rates are edging upward to more normalized levels. The housing momentum seen in 2012 and in the first half of 2013 had slowed down in the past 3-4 months, hurt by the recent spike in mortgage rates, rising home prices, tight credit availability and by political uncertainty in Washington.
Thanks to Bernanke’s decision to keep the benchmark interest rates low for quite some time, homebuilders were among the biggest winners on the day yesterday.
The broader housing market also enjoyed a strong rally and the SPDR S&P Homebuilders (XHB - Free Report) gained 3.0%. Moreover, the Dow Jones and S&P 500 index surged to record highs. However, U.S Treasury prices went down.
Further, strong housing data released in the week also pushed share prices of homebuilders.
Yesterday, data published by the U.S. Department of Housing and Urban Development and the U.S. Census Bureau showed that November housing starts surged to their highest in nearly six years. Further, data published by The National Association of Home Builders (NAHB) showed that the homebuilder sentiment index rose for the seventh consecutive month in December, showing that the recent interest rate hikes have not dampened the housing recovery.