Bloomberg data ( Charts created by Abe Cofnas and Reynolds Lee )Today, it is hard to find a scenario in housing start and housing price data that justifies being bullish on housing. The overlay of the Philadelphia Housing Index versus the US Dollar Index shows the irrepressible sinking of housing values in sync with the decline of the dollar.
The trials and tribulations of the dollar bulls are by now a well honed theme among traders. When the collapse of the dollar is almost a unanimous sentiment it may be time to think about scenarios of a recovery. The elements of a recovery are known; they will be the result of a balance of factors and a balance of fears. When the Federal Reserve stops increasing rates; when inflationary pressures are feared more than a slowdown in growth; when Oil stops surging up; these and other factors will become the catalyst for a dollar resurgence. The challenge for the forex trader will be to detect early signs. How can this be accomplished?
One of the best sources of fundamental as well as technical data to recognize a shift in the US Dollar prospects is found inside the data generated by the housing sector. Housing data, for any currency pair, whether it is mortgage debt, housing starts, construction permits, housing price data, and many other variations are leading indicators for YOU the forex trader. The fundamental reasons for the connection between forex and housing is the fact that when housing prices are rising or expected to rise, central banks are reluctant to cut rates, fearing growth in inflation. When housing prices are slumping, or expected to decline, central banks have "breathing room" to cut rates because their fear of inflationary pressures are lowered. Mortgage debt financing also plays a key factor in shaping central bank fears.
If mortgage debt becomes very large as a percentage of GDP, it means that economic growth is based on highly leveraged capital resulting in instability and undermines monetary policy. The IMF reports that: "residential investments appears to lead the business cycle in manay advanced economies, and softening of housing construction may be an important factor leading to a cyclical downturn." This relationship prevails throughout the G 8 economies. ( See : The Changing Housing Cycle and the Implication for Monetary Policy , IMF (http://www.imf.org/external/pubs/ft/weo/2008/01/pdf/c3.pdf)
Yet there may be another force emerging to rescue the almost extinct species known as dollar bulls: housing affordability. It is exactly because prices are significantly down, that at some point the opportunity to buy an existing or new home will have an increased appeal. Of course for those housing "flippers" who now have to hold on to inventory longer than previously anticipated, lower prices = bad news. But for new entrants into the housing market, there is a point where market mechanisms will clear the existing inventory.
Yes, we are not at that point yet. But there is a set of indexes relating to housing affordability that may be the handwriting on the wall the dollar bulls are looking for. There is the Housing Affordability Composite Index, and the Housing Affordability for First time homebuyers. The Housing Affordability Composite Index works as follows: When the index reaches 100, a family can afford the median price of a home. The Housing affordability index works as follows: when the index =100, first time buyers earn the ability to afford a home using a 10% down payment. In other words, first time buyers are able (with a 10% down payment) to afford the mortgage carrying cost. The National Association of Realtors produces these indexes.
Source: Bloomberg data: Charts Created by Abe Cofnas and Reynolds Lee.
We can see in the Housing Affordability Composite chart that a turn has occurred. The market is beginning to work! The process isn't overnight and especially in fundamentals it takes time. But this means that you the forex trader has time to prepare. Look at the following Chart which shows that affordability is related to currencies. As affordability reached its low point ( highest point on chart) the DXY starts to decline. Now affordability is increasing ( inverse index is declining) and the DXY is sliding down.
The data doesn't mean that the housing market has bottomed out. But it DOES mean that bottom fishing is occurring. Increased affordability translates into increased demand for housing. Increased demand for housing translates into decreased probability of further declines in interest rates. Using affordability analysis, Dollar bulls may not have to wait too much longer as affordability is increasing...
The housing collapse may have started in the USA but is viral in nature (witness the globalization of the sub-prime credit market crises) and has spread already to Britain. Perhaps we should call it the housing forex flu? Housing prices in Britain are being predicted to drop 9% this year. As a result, the British pound sterling could be experiencing a decline similar to the US dollar.
Forex traders looking to use British housing market data (to play out the decline or recovery of that currency) can monitor the First Time Buyer Affordability Index (issued by the Nationwide Building Society.) This index measures affordability by tracking initial mortgage payments as a percentage of take home pay. A rising index is a leading indicator of less affordability. It is an index worth watching!
I believe we can conclude that; based on affordability analysis, Dollar bulls may NOT have to wait too much longer in the US and we should keep a keen eye on housing markets elsewhere.
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