Will Higher Rates Kill the Housing Rally?

As we wrote in an early post, rising interest rates is among 2013's top investment themes.

A year ago, the yield on 10-Year U.S. Treasuries (^TNX) hit an all-time low of 1.379%. But since then, it's been up, up, and away.

The 10-year yield (NYSEARCA:IEF) is near 2.50% and has spiked an incredible 55% since early May. And rates for 30-year fixed mortgages have jumped to 4.51% from 3.34% at the start of the year, according to Freddie Mac.

The Mortgage Bankers Association reports its weekly refinance index has fallen by more than 50% since early May.

The latest data from S&P's Case-Shiller Home Price Index reports:

"U.S. home prices showed average home prices increased 11.6% and 12.1% for the 10- and 20-City Composites in the 12 months ending in April 2013. From March to April, the 10- and 20-City Composites rose 2.6% and 2.5%. All 20 cities showed increases over their levels from 12 months ago. Twelve MSAs - Atlanta, Detroit, Las Vegas, Los Angeles, Miami, Minneapolis, Phoenix, Portland, San Diego, San Francisco, Seattle and Tampa - continued to show double-digit annual gains. Out of these 12 MSAs, Phoenix and Tampa were the only cities to show year-over-year deceleration."

Although home prices have staged an impressive rebound, the S&P/Case-Shiller 20-City Index is still 32% lower compared to its 2007 peak.

While it may yet take a few more months for the housing market to feel the pain of higher rates, ETFs closely tied to the U.S. housing marketare already signaling warning signs.

The iShares Mortgage Real Estate Capped ETF (NYSEARCA:REM), iShares DJ US Home Construction ETF (NYSEARCA:ITB), and the SPDR S&P Homebuilders ETF (NYSEARCA:XHB) have slid between 5.5% to 16.5% over the past two months. The iShares Barclays MBS ETF (NYSEARCA:MBB) has slid 2.4%, which is almost two years worth of its current yield! The table below shows the relative performance for housing related ETFs since mid-May 2013. For home buyers, higher borrowing rates will make home affordability harder. And if the 10-year yield dances with 3%, it won't be good for the rate sensitive housing market.

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