U.S. Housing: A soft landing?

Last week we took a look at some pretty compelling evidence that the U.S. housing market is a bubble ready to burst. There is already a great oversupply in housing, the Fed will overshoot neutral causing the yield curve to invert and high energy prices will have a profoundly negative effect on the U.S. economy. The combination of these factors will cause a "perfect storm" for the housing market.

Today, we'll examine the argument that prices will moderate but supply will not dramatically outpace demand and the market glides in for a perfect landing.

Housing
In this scenario, both demand fundamentals (household formation from immigration and population growth) and affordability (interest rates and wages) continue to prop up home prices. While the supply of new homes for sale is currently at 4 1/2 year highs, this supply level will remain manageable because long-term interest rates are still close to historical lows, the rate of new ARMs is declining and a pullback in the use of home equity loans has begun.

A Steepening Yield Curve
While the Fed has raised the discount rate 12 consecutive times, from 1% to 4%, and could continue to tighten, there is no danger that the Fed could "overshoot neutral". Even if rates rise another 50-75 basis points, that would not be restrictive for growth. There will be no yield curve inversion and we may, in fact, see inflation creep upward.

Energy Prices Moderate
While higher prices, especially for natural gas this winter, will be economically dampening, this will be temporary and manageable. We've already seen oil prices fall significantly and they will continue to moderate and stabilize below $60/barrel.

Provided that these factors hold true, a bubble-bursting dramatic decline in housing prices is not likely.

Data from the October 27, 2005 ML RIC Report