The basic relationship between supply, prices and demand leads to the economic rule of thumb "high prices fix high prices." The stunning recovery in U.S. home builder stocks may prove the latest example.
Our chart showing the price of U.S. home builder stocks compared with two-year Treasury bonds was presented in a report from Bank of America chief investment strategist Michael Hartnett. The clear implication is that home builder stocks are a leading indicator for interest rates.
More importantly, the recent rally in the sector may provide a warning that U.S. interest rate policy will not remain accommodative for much longer. While not expected in the coming few quarters, an interest rate hike by the Fed would shock both equity and housing markets and likely cause a significant correction.
Fed chairman Ben Bernanke has more or less guaranteed that rates will remain extremely low until the unemployment rate falls to 7 per cent. If the housing market and job creation improve at roughly the same pace, the Fed's stimulus policy will have proven a success. But a rapid increase in housing activity that pushes up prices much faster than job creation may force the central bank to raise rates before the employment target has been reached.
In either case, a less stimulative Federal Reserve may become a reality far more quickly than investors currently believe.
Scott Barlow