The US housing market has just taken another hit

Back in early February, Minneapolis Fed President Neel Kashkari went on CNBC to make clear that loosening economic conditions, including mortgage rates that had fallen to 6.09% at the time, could disrupt the Fed’s inflation battle if it sees the economy heating up.

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“The [U.S.] the housing market is starting to show signs of life again because mortgage rates have come down again,” Kashkari said. “You’re right. [loosening financial conditions] making our jobs harder to balance the economy. All things being equal, that means we need to do more with our other tools.”

In the days following that interview, financial markets tightened, and the average 30-year fixed mortgage rate shot back to 6.97% as of Friday, as investors realized that improved economic data means the Federal Reserve is likely to keep the federal funds rate higher for longer than previously expected.

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

Already, mortgage applications – a leading indicator of home sales volumes – have started to fall again. In fact, this week’s seasonally adjusted index for mortgage purchases came in at its lowest level since 1995.

“After a brief revival in application activity in January when mortgage rates fell to 6.2%, it has now been three weeks of declining applications as mortgage rates have jumped 50 basis points in the past month,” wrote Joel Kan, the deputy chairman. chief economist at Boligkredittforeningen, earlier this week. “Inflation, employment and economic activity data have signaled that inflation may not cool as quickly as expected, continuing to put upward pressure on interest rates.”

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The economic shock from this latest jump in mortgage rates means that the downturn in the US housing market will continue, and may even deepen, and risk pushing the US economy into recession.

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

Historically, the economic impact of the Fed’s inflation battle always hits housing first. It goes like this: The central bank starts by putting upward pressure on interest rates. Not long after, house sales drop and house builders start cutting back. This leads to a fall in demand for both goods (such as timber) and durable goods (such as refrigerators). These economic contractions quickly spread throughout the rest of the economy and, in theory, contribute to curbing ongoing inflation.

The question going forward is whether the housing market can absorb these economic shocks without it spreading to the rest of the economy. On the one hand, private housing investment (ie housing GDP) has already seen a sharp decline. On the other hand, home construction employment remains at the peak of the cycle as builders avoid layoffs as they work through the historic backlog they accumulated during the pandemic housing boom.

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While increased mortgage interest rates have led to a historic decline in home sales, it has not led to a house price crash. Through December, US single-family home prices as measured by the seasonally adjusted Case-Shiller National Home Price Index (see chart above) are down 2.7% from their peak in June 2022. Without seasonal adjustment, national home prices are down 4.4%. (Keep in mind that some regional housing markets still haven’t seen a downturn.)

“Housing bubbles have re-emerged since 2020, with signs of a pandemic housing boom extending beyond the United States to other, mostly advanced, economies. While housing price inflation has recently begun to moderate—or, in some countries, abate—the risk of a deep global housing slump persists,” Dallas Fed economists wrote earlier this week.

Going forward, Dallas Fed economists expect the US housing market to continue to go through a “modest” home price correction. However, if the Federal Reserve were to become even more aggressive in its fight against inflation, it could create a “severe” correction in national housing prices.

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

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

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