MainStreet Macro: Hot Summer Housing Market

July 25, 2022 | read time icon 3 min

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Hot Summer Housing Market

With most of the country withering in the summer heat, one sector of the economy appears to be cooling. After home prices took off in the early days of the pandemic, the white-hot housing market now appears to be cooling as sales slow.

But looks can be deceiving. As the Federal Reserve prepares to raise rates again this week, housing has become a special case in the central bank’s battle against inflation. Historically, rising rate environments have cooled homebuyer demand and slowed overbuilding.

But what effect will higher rates have on a market suffering from too-little building and a decade of pent-up demand? No one knows for sure, but here’s how housing could thwart the Fed’s effort to slow inflation.

Demand might be cooling, but prices aren’t

Last week, we learned that existing home sales in June were down 14.2 percent in from the previous year.

What’s putting on the brakes? Mortgage rates, for starters. Borrowing costs have soared, with the average 30-year, fixed-rate mortgage reaching 5.54 percent last week, almost double the rate from a year ago.

Higher rates mean increased borrowing costs, which means the cost of owning a house goes up. So as rates rise, fewer people can afford to buy. 

Compounding the added cost of higher rates is the supply shortage. In June, the typical home was on the market for only 14 days, according to the National Association of Realtors, the fewest since the trade group began tracking the data in May 2011. Eighty-eight percent of homes sold in June were on the market for less than a month

High demand and lack of supply pushed the price of a typical home in the U.S. up by 13.4 percent in June from a year earlier, to $416,000, the highest price on record in Realtor data going back to 1999.

Fed rate hikes probably will make things worse for homebuyers

Housing is one of the most rate-sensitive parts of the economy. That means decisions by Federal Reserve policymakers could make the supply shortage worse, not better.    

A measure of homebuilder confidence nosedived this month to 55, down from 80 a year earlier, with builders expressing worry about higher interest rates, lower foot traffic, and surging land and construction costs. It was the seventh-straight monthly decline in the National Association of Home Builders index.

Builders might be pulling back because of higher financing costs. For the first time in two years, starts of new single-family houses fell below an annual pace of a million units for the first time since June 2020.

Housing costs are heating up inflation

Housing costs account for a third of consumer price inflation. And higher housing costs aren’t not hurting just homebuyers. Rents, too, are spiking this summer.

Higher interest rates are a double whammy for apartments and rental houses because they depress new construction and increase competition for rentals by keeping would-be buyers from owning.

Both the rental and purchase markets will keep inflation elevated in coming months.

Housing prices show up in inflation readings with a lag. The government measures housing prices only every six months, so increases are slow to find their way into inflation data. And people tend to sign year-long rental agreements, which means statisticians observe price changes far less frequently than they do in goods and other services.

My Take

Housing is the largest part of the Main Street’s budget. It’s also the most direct channel for delivering the effects of Fed interest rate policy to Main Street.

Historically, when inflation soared, the Fed was able to increase rates to cool homebuyer demand and slow overbuilding of new homes. That made monetary policy effective. But – and these are words you never want to hear from an economist – this time is different.

In today’s economy, housing is a special case in the inflation basket of goods and services. The sector’s supply woes have been chronic for a decade.

Demand might dip under pressure from higher rates. But with millennials deep into peak homebuying age and Gen Z running up behind them, demand will surge again as soon as new homes hit the market. Higher interest rates can’t balance the supply mismatch. In fact, it could end up exacerbating housing shortages.

Even as we can expect to see relief from surging energy and food prices this year, it will take more than higher interest rates to cool housing inflation – it will take more supply.