The Housing Market Tells the Federal Reserve, “Bring it on!”
Former JPMorgan Chase Global Chief Economist & PH.D in Economics
In a 2006 movie release named “Bring It On: All or Nothing,” a group of young women (represented by Beyonce’s sister Solange and Rihanna) faced a fierce cheerleading competition! It was a Darwinian battle that made it one of the most iconic movies of the decade.
The housing market is facing a similar challenge as the Federal Reserve raised short-term rates pushing mortgage rates to rise to their highest levels since the Global Financial crisis, GFC (2006-2008). But many realtors and homebuyers seem to be echoing the sentiment of the movie!
If our baseline view that a Category 1 or Category 2 economic hurricane hits our economic shores is correct, we believe that the fundamentals of the housing market are strong enough to prevent a catastrophic GFC housing market outcome.
Still rising home prices and higher mortgage rates are exposing prospective homebuyers to levels of stress not seen since the Global Financial crisis. With these effects, the current price trajectory appears unsustainable and suggests a slight cooling of the U.S. housing market is in order!
The Housing Affordability Index (HAI) measures the ability of a typical family to purchase a median price home. In its latest reading for April 2022, the index equaled 109.2, implying that the median family earned 109.2% of the income needed to qualify for a mortgage for a median-priced home. So as housing prices and mortgage rates have risen, the HAI has moved lower.
An alternative metric that reviews the relationship between Case-Shiller national housing prices and Household Median Income reaches the same conclusion.
Is the Market Functioning Properly?
Yes! During the last few years, the biggest gripe from prospective Homebuyers and Realtors alike has centered on the lack of inventory! The explosion in housing prices has led to an outsized rise in the number of homes under construction (since 2006). That was the same year the movie “Bring it on, All or Nothing.” was released!
This happened despite supply-chain issues associated with the scarcity of raw materials and the challenges of securing workers to build the homes.
As a result of this construction boom, the supply of New Homes (which account for 9.5% of the Residential Housing Market) jumped to an above-average 9-month reading. In normal periods, that figure averages 6 months.
Does This Mean That the Housing Market is Heading For a 2006-2008 Crash Landing?
Not really! A broader reading of the entire U.S. Housing Market compiled by the U.S. Bureau of the Census reveals that we have a total of 15.1 million vacant housing units today, sharply below the 19.1 million units peak reading during the GFC.
Household formations have also rebounded nicely over the past 18 months and should offer the housing market an additional near-term boost!
A monthly survey conducted by the National Association of Realtors of Existing Homes which accounts for 90.5% of the U.S. Residential Housing Market reveals that the monthly (inventory) supply stood at 2.6 months in May 2022. That reading is well below its historical average of 6.0-months.
Concluding Thoughts:
Rising U.S. mortgage rates and higher home prices should result in a moderation of housing market conditions. The big question, however, is whether the slowdown will be akin to what was observed during the GFC when Case-Shiller Housing National Price Index dropped by 25.9 % from March 2006 to February 2012? Earlier reports estimated the peak to trough decline of around 30% but subsequent revisions now peg the dip as being less steep.
The latest lean inventory levels suggest that a crash scenario is a low probability outcome. However, the ultimate outcome will depend on the depth of any potential economic slowdown resulting from the Fed’s restrictive monetary actions.
Based on our baseline view that a U.S. recession is likely to be of relatively short duration, we believe that the housing market will survive the fierce hurricane winds of any economic slowdown and end up on the side of the “Winning Team.”
It is no wonder that the U.S. Housing Market is looking to the Federal Reserve and saying, “Bring it On!”