The #1 Reason Why Homebuilders Expect Recovery In 2010

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An object in motion tends to stay in motion unless acted upon by an outside force.  We learned this from Isaac Newton 321 years ago.  And although the Netwon's First Law describes the physical world, it's relevant to the economy, too.

How else can we explain this chart from the Wall Street Journal?

Even as homebuilders predict pain in 2009 and carry confidence readings in the single-digits, they still expect a rosy 2010, it seems.  With current new home inventory at 11-plus months, this is a strange way of thinking.  Especially as the growing number of foreclosures dilutes home supply in the nation's largest markets.

So when we see homebuilder optimism for 2010, we can attribute it to the industry's belief that the government's will behave like an "outside force" on housing.  More commonly, this sort of force is called a "stimulus package" and the homebuilders aren't alone in expecting a big one.

Mortgage bond traders have been getting in on the act, too, projecting their stimulus expectations into the market's day-to-day pricing.  If you've been shopping for a mortgage this week, you've probably noticed that rates are rising and that fees are, too.  This is because mortgage rates are based on mortgage bond pricing and pricing is reflecting market sentiment.

Economic uncertainty made the rate-shopping process tough toward the end of 2008. Today, that challenge is magnified because of political uncertainty.  It's still unclear how the Obama administration will "fix the economy" and until a plan is made public, the uncertainty will remain.

Markets don't like uncertainty.  It makes them jumpy.

The only thing that mortgage markets can count on right now is that there will be some sort of outside force on bond prices and it will come in the form of an economic stimulus package.  The ongoing debate, of course, is about how large that stimulus package will be.  This is what will decide the future of mortgage rates.

For example, a stimulus package that's too large could have two mortgage-rate damaging effects:

1. It could draw money away from bonds into stocks, causing a rapid sell-off that depresses prices and raises rates. The Fed's ability to counter-balance a run like this would be limited.
2. It could lead to monetary supply inflation which, in turn, would spark a meteoric rise in mortgage rates.  Think 10 percent or higher.

Right now, the "too large" scenario is what markets are fearing.  Nobody seems to be even considering "too small".  That's one big reason why mortgage rates have been up for the past 5 days.  And until the size and scope of the pending stimulus package is defined, mortgage rates should remain jittery.

Float at your own risk.