MARKET TURMOIL CLOUDS THE RECOVERY : As Dollar Fades, So Does Optimism : California Casts a Wary Eye at Fed and Hopes for Stability

The specter of additional interest rate hikes by the Federal Reserve Board in response to this week’s fall in the dollar’s value has sent more chills through some Californians, who fear such a move could further endanger the state’s nascent economic recovery.

Though there is no sign yet that the Fed will act to boost short-term rates, the fear is real that more increases could damage the state’s housing industry, which experts look to as the locomotive pulling the state out of its four-year recession.

“The market seems to have absorbed the rise in mortgage rates to date, but another (percentage) point would put them up at close to 9.5% or 10% . . . and it would seem likely that that would cut into sales and new construction,” said Stephen Levy, director of the Center for Continuing Study of the California Economy in Palo Alto.

Rising mortgage rates in the spring--sparked by the Fed’s earlier rate increases, which were designed to head off inflation--contributed to a 4.5% month-to-month decline in home sales in May, though sales were 20% above year-ago levels, the California Assn. of Realtors reported Thursday.

Moreover, the UCLA Business Forecasting Project on Wednesday reported that the state’s economic growth in 1994 would be weak, in part because rising interest rates were adversely affecting the housing market.

Peter Moyer, who owns Century 21 real estate brokerages in Orange and Yorba Linda, said the initial rise in interest rates late last year was good for business, scaring people into the home-buying market and causing a surge from December to March.

“Then they creeped a little too high, and there was a slowdown, but not to the depths of last year,” he said. But he worries about a further hike. A one-point increase “would be disastrous,” he said. “It reduces significantly the number of qualified buyers available.”

Not everyone is pessimistic, however.

David Hensley, former head of UCLA’s Business Forecasting Project and now regional economist with Salomon Bros. in New York, argues that housing in California would remain very affordable by historical standards even if long-term rates went as high as 10%--which he thinks is unlikely. (Consumers also tend to turn to adjustable-rate mortgages as fixed-rate mortgages climb.)

He predicts that the yield on 30-year Treasury bonds, a key indicator of long-term rates, will remain below 8%. On Friday, bond values fell, sending yields up to 7.52% from 7.40% the day before.

“I think the housing market in California can withstand higher rates,” Hensley said. Even an increase in mortgage rates to 9.5% or 10% from their current 8% or 8.5% “would not be catastrophic, though it would be cause for concern,” he said.

On Friday, the Fed and other central banks moved to buy up dollars on global currency markets to prop up the greenback, whose value has fallen dramatically in recent days, causing turmoil in stock and bond markets.

The Fed is not expected to make any decision on short-term interest rates until the July 5 meeting of its Open Market Committee.

Contrary to historical patterns, the state’s current recovery does not yet include a robust increase in new home construction, said Pauline Sweezey, chief economist with the state Department of Finance in Sacramento.

“And we are, of course, concerned that any significant rise in long-term interest rates will stunt any incipient housing recovery,” she said.

If the Fed makes it clear it is raising rates because of international exchange rate concerns and not to head off inflation, it would raise expectations that rates could fall again soon, thereby mitigating the effects of such a hike, Levy said.

Rising Rates

Recent rises in bond yields have forced up mortgage rates, hurting the California housing market. Thirty-year Treasury bond yields since May 24; daily closes:

Friday: 7.52%