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Two Bank of America Merrill Lynch Analysts Predict Home Prices to Level Off and Reverse Course Within 2 Years

Two Bank of America Merrill Lynch (BAML) analysts are defending what they call their big high conviction views for what should happen in the housing world over the next two years. Chris Flanagan and Gregory Fitter, ABS and MBS strategists say that their views are not mainstream but that recent data has corroborated their theories.

The two contend that home price increases will continue to moderate from the skyrocket trajectory they were on in late 2012 and early 2013 will peak in mid-2016. Second, as unemployment continues to ease, the yield curve will continue to flatten (longer term rates getting lower while shorter term rates get higher, relative to each other) and the spread between two year and 10 year treasury yields should be at zero by the time home prices peak. The long end of the curve will remain at surprising low yields, fostered by a soft housing market and low inflation.

The first "big view", that home prices will peak in two years is validated they say by the most recent income based home price model from Case Shiller. Charts 1 and 2 includes the Case Shiller historical and forecasted home price index (HPI) along with the BoA strategists' estimate of fair value. This model shows that the HPI will increase from the first quarter 2014 level of 155.5 to a peak of 167.3 in the third quarter of 2016. This is an annualized growth of 3 percent over 30 months compared to 11 percent in 2013 and the 9.5 percent annualized rate since prices bottomed in the fourth quarter of 2011. Then prices are expected to decline and not recover to the 2016 level until Q2 2022, an annualized rate of price growth over six years of 0. With this factored in, the annualized home price growth rate between Q1 2014 and Q2 2022 is expected to be 1.0 percent.

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