U.S. mortgage watchers worry about China FX move
Updated: 2006-01-11 09:11
China's recent signal that it may diversify its foreign investments in 2006
has mortgage industry watchers concerned that if China buys fewer U.S. Treasury
securities this year, it may drive interest rates higher and pour more cold
water on the real estate market.
Last week, China's foreign currency regulator said its plans for 2006 include
"actively exploring more efficient use of our FX (foreign-exchange) reserve
assets" and "widening the foreign exchange reserves investment scope."
While China's central bank said Tuesday it has no plans to sell dollars from
its $800 billion-plus foreign reserves, some analysts predict China may buy less
U.S. government debt at Treasury auctions this year.
Like Japan, China is
a large buyer of U.S. Treasuries and other U.S. debt such as securities issued
by housing agencies Freddie Mac and Fannie Mae. China sees the U.S. debt market
as stable and liquid versus other countries' debt and its purchases have helped
keep U.S. interest rates relatively low in recent years.
While it is not
certain exactly how a drop in China's demand for U.S. government debt would show
up, Ken Hackel, chief fixed income analyst at RBS Greenwich Capital Markets,
believes there could fewer purchases of five- and 10-year U.S. government notes
at regular U.S. Treasury auctions.
As a result, "there may be somewhat
higher yields ... over time," Hackel said. He added that China likely won't
completely exit the U.S. government debt market, but merely pare back its
Home mortgage rates are closely tied to Treasury rates and any
rise in the cost of borrowing could further slow home sales. A series of
increases in the overnight bank lending rate by the Federal Reserve since 2004
has already made adjustable-rate mortgages more pricey. Further rises in the
yield of 10-year Treasury notes, which lenders use as a benchmark for rates they
charge for 15- and 30-year fixed-rate mortgages, could make those mortgages more
expensive as well.
Last week, 30-year mortgages averaged 6.21 percent, up
from 5.77 percent a year ago, according to Freddie Mac.
"If it comes to
pass that long-term Treasury yields are higher, that means that mortgage rates
will become more expensive for consumers," said Frank Nothaft, chief economist
at Freddie Mac, one of two housing agencies chartered by Congress to help
lenders resell their mortgages on Wall Street.
"The added burden of a
rise in interest rates, even a small one, is of no help" to consumers or their
lenders, said Keith Gumbinger of HSH Associates, which tracks mortgage
While China has signaled a shift in its buying patterns, it likely
won't completely abandon U.S. dollar denominated assets like debt issued by
Fannie Mae and Freddie Mac.
"They (China) ship a lot of goods to
Wal-Mart. Wal-Mart pays for these goods in dollars and manufacturers in China
trade these for China's local currency and eventually the dollars work their way
into China's central bank," said Chris Low, chief economist at FTN
China's central bankers have a choice of investing the U.S.
currency in dollar denominated assets like U.S. Treasury bonds or they can trade
the dollars for other currencies.
"If they diversify from the U.S. dollar
denominated assets, it would lower the value of the U.S. dollar relative to
China's currency, the yuan, and make it more expensive for American companies to
buy goods made in China," said Low, adding that he does not expect China let its
currency rise in value by selling U.S. dollars.
Nothaft and Hackel also
point out that any drop in demand from China could be made up for by investors
like U.S. brokerage firms or foreign investors, containing a rise in U.S.
While mortgage rates today are up from their record lows,
they are still much lower than the double digit rates seen in the 1980s. But
there are signs that higher borrowing costs already are weighing on
The National Association of Realtors said last week its measure of
sales contracts signed in November dropped 2.5 percent, a third consecutive
decline. On Tuesday, The association said it expects the 30-year fixed-rate
mortgage to rise gradually to 6.7 percent during the second half of the
While Hackel believes the change in China's buying of Treasuries
should result in a marginal increase in mortgage rates, David Olson of Wholesale
Access, a firm that tracks the mortgage banking industry, believes mortgage
rates could be as much as half a percentage point higher.
"I don't think
they (China) are going away completely, but if they do then we're going to have
quite a runup in rates," said Olson.