A roof over its head

A confounding feature of the post-pandemic U.S. expansion is the asynchronous pattern of results of different segments of the economy. One that stands out is the housing market, in which activity is at recessionary levels even as broad GDP growth outpaces expectations. Despite the current malaise in this sector, a close look at the data reveals potential for a more positive outlook. `

After a surge in activity following the reopening of the economy in mid-2020 that carried all the way through 2021, the housing market has slowed significantly. According to the National Association of Realtors, the pace of existing home transactions has declined by a third from about 6 million to a 13-year low of 3.96 million units in September. The historically low level of inventory is contributing to the decline, with just over 1 million homes listed for sale across the country. To put that in perspective, there are now approximately 1.5 realtors in the U.S. for every home on the market! And those listed are priced beyond the budget of a typical buyer. Affordability—the median family income relative to the median-price resale home—sits at its lowest level since the mid 1980s (the first time this measure was captured).

The blame for the weakness falls squarely on the rapid increase of mortgage rates resulting from the Fed’s hiking regime. Having just touched 8%, they are nearly twice as high as pre-Covid compared to the 10-year Treasury yield, an atypically wide spread. Realized volatility in long-dated Treasury instruments has surged to levels normally associated with equities, making the issuance of fixed-rate mortgages less attractive. The severe losses in bank-securities portfolios also have deterred mortgage supply. While earlier this year the new home market did benefit from the low existing inventory, rates are now biting there, as well. The National Association of Home Builders Housing Market Index has responded in concert, declining three consecutive months. 

With such bleak performance, what leads us to conclude better results for housing may be on the horizon? The Fed’s most recent Summary of Economic Projections provides the foundation for a constructive path: modestly higher unemployment, gradual reduction of inflation measures and a tightening cycle on hold after perhaps only one more quarter-point hike. In this scenario, Treasury volatility would likely decline and mortgage rates eventually normalize to a spread consistent with prior unstressed periods, with 6% a reasonable target.

Human psychology then comes into play. After the sub-3% nadir in early 2021, 6% seemed untenable. But the perspective becomes different when approached from 8%. As prospective buyers and sellers rationalize the new rate reality, activity should be unleashed. A return to a more typical 5.5 million pace of existing home sales is a possibility. At a minimum, the housing-sales multiplier effect on economic growth reduces the likelihood of a hard landing scenario. Should a number of sectors manage to sync with housing, an extension—and even acceleration—in the economic expansion is not out of the question.