On the front page of two of the nationââ,¬â"¢s top newspapers, the New York Times and the Chicago Tribune are articles today about the burden of higher housing costs on the middle class (links to the articles are at the bottom of this report).  At a time when the housing market is losing steam and prices are falling, homeowners can no longer fall back on the rising value of their home as an excuse for dealing with higher mortgage payments.  Over the past 2.5 years, the Federal Reserve has increased interest rates from 1.00 percent to 5.25 percent, which means that for some, housing costs may have increased by more than 50 percent.  We have long warned in our daily reports that the persistent interest rate hikes by the Federal Reserve poses a big risk for the US consumer, US economy and the US dollar and todayââ,¬â"¢s news reports are clear evidence of that.  

How Much Money Does the US Consumer Really Have Left?

According to the NY Times, the number of people paying at least 30 percent of their gross income on housing increased significantly over the past five years.  In New York City, at least 50 percent of people pay 30 percent of their income on housing.  In Southern California, this balloons to 74 percent.  The most surprising figures are found in Boulder, Colorado and College Station, Texas where more than 45 percent of people with mortgages spend at least 50 percent of their income just on housing.  This means that if the average median income in the US is $45,000 or $3,750 per month, spending 50 percent of your pre tax income on rent equals to a monthly payment of $1,875.  For the same income level, taxes probably amount to $750 a month, which leaves an after tax income of $1,125.  Assuming that miscellaneous expenses such as heating, home phone, cell phone, internet, and cable bills come to $300 a month, this leaves only $825 a month or $206 a week in true discretionary income which is an extremely small.  This goes to show how stretched consumers are at the moment.  The savings rate in the US is negative, which means that most people are dipping into their savings to fund their spending.  Incomes are not growing at the same pace to help relieve some of that burden but what is most worrisome is the fact that low income counties have seen the biggest hit.  These are the people who can least afford to shop aggressively this holiday season. 

Will the Housing Market Turn Around?

Unfortunately things will most likely get worse before they get better for the housing market.  With $1 trillion worth of adjustable rate mortgages resetting this year, there are still more homeowners that will face the burden of higher mortgage costs.  New and existing home sale figures have been very disappointing over the past few months and inventories are rising overall.  We are comforted by the fact that pending home sales bounced in August, but we would certainly need to see more than one positive reading from the housing market before calling a bottom.  Thankfully the drop in oil prices has made things a lot easier for the average consumer and could keep them spending for a bit longer, but if the housing market continues to worsen, the only solution may be for the Federal Reserve to step in and lower interest rates.  By doing so, they would reduce the rates at which these adjustable rate mortgages are reset to, which would help to reduce some of the housing market costs.  The Fed is not quite ready to take that step at the moment because the extent of the downturn in the housing market is still relatively shallow they are still waiting on evidence of a significant impact on consumer spending.  Next week, we are expecting the September retail sales report.  For those hoping for a rate cut, a weak number may be the first indication of that possibility.

Rate Cut Negative for the Dollar

Interest rate cuts are good for the consumer because it reduces mortgage rates and credit card payments but at the same time, it can be very negative for the US dollar.  For those watching the currency markets, trading has been extraordinarily quiet.  Everyone is sitting on the sidelines waiting to jump into the next big trade.  The Federal Reserve has kept interest rates on hold since August and recent economic data has warranted no further changes to interest rates for the time being.  However, if consumers can no longer carry the burden of the rising housing costs, then the Federal Reserve may need to cut interest rates.  One reduction is usually followed by more and in a world where money shifts from country to country in seek of high and growing yield, a rate cut by the Federal Reserve could lead to a mass exodus out of US dollars.  This could come to the benefit of currencies such as the Euro, British pound and Japanese Yen.  Realistically though, we do not expect the Federal Reserve to sweep in and save day until next year. 

Kathy Lien is the Chief Currency Strategist at FXCM.