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U.S. housing market has slowed significantly, says chief investment officer of PIMCO Investment Management

Newsletter Aug.29,2022 07:45

"We do think the housing market is going to slow, and it's going to slow significantly," Dan Ivascyn, chief investment officer at PIMCO, which manages more than $2 trillion in assets, said on the latest episode of the Odd Lots podcast. "We believe that nationally, the real value of house prices, adjusted for inflation, is likely to fall over the next few years."

He added: "Our view is that house prices will stabilize near zero growth or very, very low single-digit growth. But if you see house prices falling across the country, that's not surprising and there's no need to be overly concerned. ."

"Such a slowdown would be a reversal of the post-pandemic trend. The post-pandemic era saw U.S. home prices soar as homebuyers en masse moved out of cities because they wanted more space. But even before the surge ignited by the pandemic, U.S. home prices were surging. Homeowners have collectively reaped years of property gains. This unstoppable rise in house prices has heightened concerns about the sustainability of price increases, housing affordability and supply.”

Now that the Fed is raising interest rates to curb inflation, house prices are much more vulnerable than they appear, Ivascyn said. Inflation in the U.S. is currently at its highest level in 40 years. He expressed concern about the Fed's ability to keep prices down without tipping the U.S. economy into recession, underscoring how big investors are finding their way through an extremely uncertain macro outlook and volatile asset prices. Real estate activity has slowed markedly since the Fed began raising interest rates, with new home sales falling 8.1% from May to June 2022, and pending home sales falling 8.6% in the same month.

Ivasin says:
“Preferences have changed dramatically since Covid-19 – people want to live farther from the office. Prices have risen quite significantly in some resort-type communities. Some areas will have less land available than others, so some There will be a huge increase in demand in regions and prices in some regions will drop outright. You'll hear more news about price cuts and a lot of that in the next few months. If you're underwriting a new mortgage Loans, especially high-risk investments, you have to be very, very careful in underwriting. But from a macro perspective, there are still too few family homes in the U.S. and other Western countries compared to the number of households that have grown over the past few years. "

Mortgage rates are a case in point in the tug-of-war between inflation concerns and slowing economic growth. The average interest rate on a 30-year loan soared to nearly 6% in June and fell below 5% last week, according to Freddie Mac. But generally higher lending rates have discouraged home purchases and sparked some oddities in the mortgage market.

For example, the gap between yields on new coupon bonds and the broader market is now at its highest level since the early 1980s, in part because soaring lending rates mean fewer new mortgages are being issued. That makes it harder to judge valuations in the mortgage market.

Challenges like these mean that large mortgage bond buyers like PIMCO are focusing on older, or more mature, housing debt. "Today, in most cases, as long as the borrower owns more than 60 percent of the property's equity, there is little risk of default even in the face of the current modest decline in home prices," Ivascyn said. It's all a quarterly risk benefiting from years of house price appreciation, so it's less sensitive to what's going on in the future."

Of course, other types of bonds have also seen volatility recently. Earlier this year, Bank of America's MOVE index of Treasury volatility jumped to its highest level since 2009, barring volatility in 2020 when the coronavirus pandemic hit. Risk premiums on corporate bonds have climbed as investors price in the possibility of an economic slowdown that could hurt corporate profits.

For example, the gap between yields on new coupon bonds and the broader market is now at its highest level since the early 1980s, in part because soaring lending rates mean fewer new mortgages are being issued. That makes it harder to judge valuations in the mortgage market.

Challenges like these mean that large mortgage bond buyers like PIMCO are focusing on older, or more mature, housing debt. "Today, in most cases, as long as the borrower owns more than 60 percent of the property's equity, there is little risk of default even in the face of the current modest decline in home prices," Ivascyn said. It's all a quarterly risk benefiting from years of house price appreciation, so it's less sensitive to what's going on in the future."

Of course, other types of bonds have also seen volatility recently. Earlier this year, Bank of America's MOVE index of Treasury volatility jumped to its highest level since 2009, barring volatility in 2020 when the coronavirus pandemic hit. Risk premiums on corporate bonds have climbed as investors price in the possibility of an economic slowdown that could hurt corporate profits.

"Our overall view is that we're facing a fairly mild but persistent recession. That's why we continue to be fairly cautious about the more credit-prone areas of the market." Ivascyn noted that less liquid ones Private credit transactions have yet to reflect recession risk as much as the more liquid public markets. However, Ivascyn said PIMCO had bought some junk-rated bonds in the recent sell-off.

At the end of the day, Ivascyn is not bearish or bearish about the market itself. He just sees a lot of risks that could derail the economy or the market, so implicitly makes a case for going wet. "We tend to cut some leverage and avoid or reduce exposure to the most sensitive areas of the market economy," he said. "It's not because of our pessimistic view. It's just that this extreme uncertainty has made investors more sensitive to credit in some areas. Be cautious in your investments, which are essentially short-volatility trades.”