The US housing market has just suffered another blow

Back in early February Minneapolis Fed President Neel Kashkari continued CNBC to clarify that the easing of financial conditions, including mortgage rates which had then fallen to 6.09%, could interfere with the Fed’s fight against inflation if it sees the economy warming up.

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“The (US) housing market is starting to show signs of life again because mortgage rates have come back down,” Kashkari said. “You’re right, it (the easing of financial conditions) makes our jobs harder to balance the economy. All things being equal, that means we should be doing more with our other tools.”

In the days following that interview, financial markets tightened and the average 30-year fixed mortgage rate rose to 6.97% on Friday as investors realized that improving economic data means the Federal Reserve is likely to hold the higher federal funds rate. longer than expected.

Realtors and homebuilders had celebrated a slight improvement in transaction levels spurred by the reduction in mortgage rates earlier this year, but this rebound in mortgage rates means that the US housing market, in terms of activity, could experience a prolonged period of sluggishness..

Already, mortgage purchase applications, a leading indicator of home sales volumes, have started to decline again. Indeed, this week’s seasonally adjusted mortgage purchase demand index hit the lowest level since 1995.

“Following a brief upturn in application activity in January when mortgage rates fell to 6.2%, there have now been three consecutive weeks of declining applications, with mortgage rates jumping 50 basis points over the of last month,” wrote Deputy Joel Kan. chief economist at the Mortgage Bankers Association earlier this week. “Inflation, employment and economic activity data signaled that inflation may not subside as quickly as expected, which continues to put upward pressure on rates.”

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The economic shock caused by this latest increase in mortgage rates means that the collapse of the American housing market will continue and could even worsen, risking to plunge the American economy into a recession.

On Tuesday, economists at the Federal Reserve Bank of Dallas warned that “perils detected in the US and German housing markets pose a vulnerability to the global outlook due to the size of these countries’ economies and significant cross-border financial spillovers.”

Historically speaking, the economic impact of the Fed’s inflation fight always hits housing first. This happens as follows: the central bank begins by exerting upward pressure on interest rates. Shortly thereafter, home sales plummet and homebuilders begin to cut spending. This leads to a fall in demand for basic products (like wood) and durable goods (like refrigerators). These economic contractions then quickly spread throughout the economy and, in theory, help to curb runaway inflation.

The question for the future is whether the housing market can absorb these economic shocks without spreading them to the rest of the economy. On the one hand, private residential fixed investment (i.e. housing GDP) has already fallen sharply. On the other hand, residential construction employment remains at its cycle peak as builders avoid layoffs by working the historic backlog they built up during the pandemic housing boom.

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Although soaring mortgage rates have translated into a historic decline in home sales, it has not translated into a fall in home prices. Through December, U.S. single-family home prices, as measured by the seasonally adjusted Case-Shiller National Home Price Index (see chart above), were down 2.7% from their high of June 2022. Without seasonal adjustment, national house prices are down 4.4%. (Keep in mind that some regional real estate markets still haven’t experienced a decline.)

“The housing moss has resurfaced since 2020, with signs of a pandemic housing boom spreading beyond the United States into other, mostly advanced, economies. recently begun to moderate — or, in some countries, diminish — the risk of a deep global housing downturn persists,” Dallas Fed economists wrote earlier this week.

Going forward, Dallas Fed economists expect the US housing market to continue to experience a “moderate” house price correction. However, if the Federal Reserve becomes even more aggressive in its fight against inflation, it could create a “severe” correction in national house prices.

“While a modest housing correction remains the base-case scenario, the risk that tighter-than-expected monetary policy could trigger a more severe price correction in Germany and the United States cannot be ignored,” the authors wrote. Dallas Fed economists earlier this week.

Want to stay up to date on the real estate recession? Follow me on Twitter at @NewsLambert.

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