Micro 30-Year Yield FuturesPanjang
30Y: Housing Cost Jumps Amid Falling Headline Inflation
CBOT: 30-Year Micro Yield Futures ( 30Y1!), Treasury Bond Futures ( 
ZB1!)
As a result of runaway inflation and rising interest rates, US home buyers are confronted by high home prices, high down payments, and high monthly mortgage payments.
A sneak peek into official housing market data between 2021 and 2023:
• Median sales price of houses sold in the US (MSPUS) was $436,800 in the first quarter of 2023, per Federal Reserve Economic Data (FRED);
• The median home price was $433,100 in Q1 2022 and $369,800 in Q1 2021. In the span of merely two years, home price jumped 18.1%;
• Thirty-year fixed rate mortgage averaged 6.81% on July 6th (MORTGAGE30US);
• The same mortgage was quoted at 5.30% a year ago and only 2.90% in July 2021.
A typical family of four living in the State of Illinois earned a median income of $113,649 in 2022, according to the U.S. Census Bureau’s survey data. The example cited below illustrates the dramatic rise in housing cost from a family perspective:
• If a 30-year-fixed mortgage is taken with a 20% down payment, the upfront cost is $87,360 (20% ofMSPUS at $436,800), which is up $13,400 or 18.1% from two years ago;
• Assuming the family’s take-home pay is 75% of gross income, their after-tax income would be $85,237 per year, or $7,103 per month;
• Down payment already exceeded annual income. Adding in closing fees, moving cost, appliances and new furniture, upfront home investment could be well over 100K;
• Using a mortgage calculator, we find that monthly mortgage payments were $1,724 if the home was bought two years ago; this equates to 24.3% of take-home pay;
• New monthly payments would be $2,682, up sharply by 55.6%; mortgage expense now takes up 40.3% of the family’s after-tax income!
This shows that an average US family these days can’t afford a median-price new home.
A Tale of Two Cities
The sharp increase in housing cost flies in the face of official US inflation data. June CPI report will be released on Wednesday. Economists forecast headline inflation to fall to 3.0% from 4.0% and core CPI to be lowered to 5.0% from 5.3% in May.
The subset of inflation data shows Shelter cost growing at 8.0% annual rate in May. This doubles the headline CPI but is still a vast understatement for the soaring housing cost.
So, where is the disconnection? Here is my theory.
High mortgage rates have a bigger impact on mortgage payments than home price appreciation. Based on my calculation, each 1% increase in interest rate would translate into 9% more in monthly mortgage payments. In our example, mortgage rate grew about 4% from 2021 to 2023, and a mortgage is taken on a home priced at 18% higher. The resulting monthly payments jumped 55.6%.
The compounding effect of higher prices and higher rates is fatal. I do not foresee either dropping in a meaningful way by next year. Therefore, do not expect the lower inflation to provide immediate relief to home buyers.
Housing Market is not likely to crash
US new home sales (USNHS) peaked at 1 million units in October 2021. Since then, it has nosedived and almost cut in half to 550K units by September 2022.
Existing home sales (USEHS) followed a similar trend. It topped out at 6.6 million units in August 2020, and dropped to 4.0 million units in January 2023.
Despite the hurdles facing home buyers, the US housing market appears to have recovered. New home sales reached 763K units in May, up nearly 12% from April. Existing home sales were 4.3 million units, up 300K from the beginning of the year.
How could the housing market hold up? Isn’t homeownership already beyond reach? According to the National Association of Realtors, 65.5% of US families are homeowners. We could say that those with a “lock-in” rate are insulated from rising housing costs.
Homeowners are “trapped” in their home in a rising interest rate environment. If they sell their houses and buy new ones, they will forfeit their 3% mortgage. This explains why existing home sales recovers at a much slower pace than new home sales. Low inventory and fewer sellers relative to buyers, together keep the housing market going strong.
Prospective home buyers are not so lucky. But they have options. First is to lower their expectation and buy a smaller home; Second is to downgrade from single family home to townhouse or condominium. Finally, postpone home purchases and continue to rent.
Several Economists predicting a housing market crash as big as the 2008 Subprime crisis. I think the Big Shorts would be disappointed this time. Prior to 2008, up to one third of homeowners had adjustable-rate mortgages. They survived rate-reset only because their house value went up. When it didn’t, they couldn’t refinance and defaulted on their loan.
These days, adjustable-rate accounts for just 5% of all mortgages. The housing market is healthier now. FRED data shows the mortgage delinquency rate at 1.73% in Q1 2023, and the rate has been declining consistently for seven quarters.
How Is This Relevant for Trading?
I hold the view that the US housing market is very resilient. As long as the job market does not deteriorate, it could weather significant challenges including higher interest rates, indicating that the demand for home mortgages would stay strong.
Whether you buy a new home or an existing one, a single-family home, a townhouse, a condo, or a trailer home, chances are you need a mortgage. The 30-year fixed rate mortgage is the most popular type of home loans in the US. Hence, this is where we should find solutions to manage interest rate risk.
Interest rate data shows that the 30-year fixed rate is not closely correlated to the Fed’s interest rate decisions. In the past 12 months, the Fed Funds rate gained 130%, while the 30-year Fixed only moved up 28%. Since last November, the Fed raised interest rates five times, but the 30-year Fixed stayed relatively unchanged.
My theory is that the decline in home sales countered the effect of rising funding cost, putting the mortgage rates in sideway moves. Now that the housing market recovers, 30-year Fixed could be on the way up. The July FOMC meeting could provide a boost if the Fed raises 25 bp as the market predicts.
There is no liquid financial instrument on the 30-year fixed rate mortgage. However, it is closely correlated to the 30-year Treasury yield. The mortgage rate currently is priced at 2.8% above the Treasury yield. The spread appears to be stable over time.
If we are bullish on the 30-year fixed mortgage rate, we could consider the following:
One, to set up a short position on CBOT Treasury Bond Futures (ZZB). Remember that bond price and yield are inversely related. Rising yield would cause the bond to lose value.
Each Treasury Bond futures contract has a face value of $100,000. The price quotation is based on $100 par value. The minimum tick is 1/32 of one point (0.03125), or 1,000/32 = $31.25. SEP contract (ZBU3) is quoted $123 and 22/32 on Monday July 10th.
Two, to set up a long position on CBOT 30-Year Micro Yield Futures (30Y). On July 10th, the August contract is quoted 4.029%.
Each 30Y contract has a notional value of interest rate times 1000 index points. A move by a minimum tick of 0.001 index point would result in a gain or loss of $1 per contract.
What’s the difference between these two? Treasury bond futures are very liquid. It traded 387,170 contracts and had an Open Interest of 1.25 million on July 7th.
Micro Yield Futures are more intuitive. If yield goes up, futures price goes up too. The contract is catered to individual investors. Its margin requirement is $290, compared to $4,200 for the bond futures.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/
30Y1!), Treasury Bond Futures ( ZB1!)As a result of runaway inflation and rising interest rates, US home buyers are confronted by high home prices, high down payments, and high monthly mortgage payments.
A sneak peek into official housing market data between 2021 and 2023:
• Median sales price of houses sold in the US (
MSPUS) was $436,800 in the first quarter of 2023, per Federal Reserve Economic Data (FRED);• The median home price was $433,100 in Q1 2022 and $369,800 in Q1 2021. In the span of merely two years, home price jumped 18.1%;
• Thirty-year fixed rate mortgage averaged 6.81% on July 6th (
MORTGAGE30US);• The same mortgage was quoted at 5.30% a year ago and only 2.90% in July 2021.
A typical family of four living in the State of Illinois earned a median income of $113,649 in 2022, according to the U.S. Census Bureau’s survey data. The example cited below illustrates the dramatic rise in housing cost from a family perspective:
• If a 30-year-fixed mortgage is taken with a 20% down payment, the upfront cost is $87,360 (20% of
MSPUS at $436,800), which is up $13,400 or 18.1% from two years ago;• Assuming the family’s take-home pay is 75% of gross income, their after-tax income would be $85,237 per year, or $7,103 per month;
• Down payment already exceeded annual income. Adding in closing fees, moving cost, appliances and new furniture, upfront home investment could be well over 100K;
• Using a mortgage calculator, we find that monthly mortgage payments were $1,724 if the home was bought two years ago; this equates to 24.3% of take-home pay;
• New monthly payments would be $2,682, up sharply by 55.6%; mortgage expense now takes up 40.3% of the family’s after-tax income!
This shows that an average US family these days can’t afford a median-price new home.
A Tale of Two Cities
The sharp increase in housing cost flies in the face of official US inflation data. June CPI report will be released on Wednesday. Economists forecast headline inflation to fall to 3.0% from 4.0% and core CPI to be lowered to 5.0% from 5.3% in May.
The subset of inflation data shows Shelter cost growing at 8.0% annual rate in May. This doubles the headline CPI but is still a vast understatement for the soaring housing cost.
So, where is the disconnection? Here is my theory.
High mortgage rates have a bigger impact on mortgage payments than home price appreciation. Based on my calculation, each 1% increase in interest rate would translate into 9% more in monthly mortgage payments. In our example, mortgage rate grew about 4% from 2021 to 2023, and a mortgage is taken on a home priced at 18% higher. The resulting monthly payments jumped 55.6%.
The compounding effect of higher prices and higher rates is fatal. I do not foresee either dropping in a meaningful way by next year. Therefore, do not expect the lower inflation to provide immediate relief to home buyers.
Housing Market is not likely to crash
US new home sales (
USNHS) peaked at 1 million units in October 2021. Since then, it has nosedived and almost cut in half to 550K units by September 2022.Existing home sales (
USEHS) followed a similar trend. It topped out at 6.6 million units in August 2020, and dropped to 4.0 million units in January 2023.Despite the hurdles facing home buyers, the US housing market appears to have recovered. New home sales reached 763K units in May, up nearly 12% from April. Existing home sales were 4.3 million units, up 300K from the beginning of the year.
How could the housing market hold up? Isn’t homeownership already beyond reach? According to the National Association of Realtors, 65.5% of US families are homeowners. We could say that those with a “lock-in” rate are insulated from rising housing costs.
Homeowners are “trapped” in their home in a rising interest rate environment. If they sell their houses and buy new ones, they will forfeit their 3% mortgage. This explains why existing home sales recovers at a much slower pace than new home sales. Low inventory and fewer sellers relative to buyers, together keep the housing market going strong.
Prospective home buyers are not so lucky. But they have options. First is to lower their expectation and buy a smaller home; Second is to downgrade from single family home to townhouse or condominium. Finally, postpone home purchases and continue to rent.
Several Economists predicting a housing market crash as big as the 2008 Subprime crisis. I think the Big Shorts would be disappointed this time. Prior to 2008, up to one third of homeowners had adjustable-rate mortgages. They survived rate-reset only because their house value went up. When it didn’t, they couldn’t refinance and defaulted on their loan.
These days, adjustable-rate accounts for just 5% of all mortgages. The housing market is healthier now. FRED data shows the mortgage delinquency rate at 1.73% in Q1 2023, and the rate has been declining consistently for seven quarters.
How Is This Relevant for Trading?
I hold the view that the US housing market is very resilient. As long as the job market does not deteriorate, it could weather significant challenges including higher interest rates, indicating that the demand for home mortgages would stay strong.
Whether you buy a new home or an existing one, a single-family home, a townhouse, a condo, or a trailer home, chances are you need a mortgage. The 30-year fixed rate mortgage is the most popular type of home loans in the US. Hence, this is where we should find solutions to manage interest rate risk.
Interest rate data shows that the 30-year fixed rate is not closely correlated to the Fed’s interest rate decisions. In the past 12 months, the Fed Funds rate gained 130%, while the 30-year Fixed only moved up 28%. Since last November, the Fed raised interest rates five times, but the 30-year Fixed stayed relatively unchanged.
My theory is that the decline in home sales countered the effect of rising funding cost, putting the mortgage rates in sideway moves. Now that the housing market recovers, 30-year Fixed could be on the way up. The July FOMC meeting could provide a boost if the Fed raises 25 bp as the market predicts.
There is no liquid financial instrument on the 30-year fixed rate mortgage. However, it is closely correlated to the 30-year Treasury yield. The mortgage rate currently is priced at 2.8% above the Treasury yield. The spread appears to be stable over time.
If we are bullish on the 30-year fixed mortgage rate, we could consider the following:
One, to set up a short position on CBOT Treasury Bond Futures (ZZB). Remember that bond price and yield are inversely related. Rising yield would cause the bond to lose value.
Each Treasury Bond futures contract has a face value of $100,000. The price quotation is based on $100 par value. The minimum tick is 1/32 of one point (0.03125), or 1,000/32 = $31.25. SEP contract (ZBU3) is quoted $123 and 22/32 on Monday July 10th.
Two, to set up a long position on CBOT 30-Year Micro Yield Futures (30Y). On July 10th, the August contract is quoted 4.029%.
Each 30Y contract has a notional value of interest rate times 1000 index points. A move by a minimum tick of 0.001 index point would result in a gain or loss of $1 per contract.
What’s the difference between these two? Treasury bond futures are very liquid. It traded 387,170 contracts and had an Open Interest of 1.25 million on July 7th.
Micro Yield Futures are more intuitive. If yield goes up, futures price goes up too. The contract is catered to individual investors. Its margin requirement is $290, compared to $4,200 for the bond futures.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/
Jim W. Huang, CFA
jimwenhuang@gmail.com
jimwenhuang@gmail.com
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