Inflation Pressures Are Easing but Rate Cut Forecast Remains Uncertain

The New Year is beginning where the old one ended -- with uncertainty about when – or whether – the Federal Reserve will begin cutting interest rates.

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Year-end housing reports reflect two competing narratives. The first: Soaring prices and strong sales producing the best housing market performance in more than a decade. The second: Higher prices, rising interest rates and skimpy inventories combining with troubling signs that millennials are losing faith in the desirability of home ownership and/or the possibility of achieving it.

We’ll start with the second theme, partly because the good news segment is fairly short, but also because millennials represent the largest cohort of prospective home buyers, making their attitudes and behavior of more than passing concern to housing industry professionals.

Some surveys have indicated that homeownership is as much a dream for millennials as it was for prior generations, concluding that it is just taking them longer to get there. Others have hinted at a sea change in their attitudes, making the dream of home ownership far less vivid for them than it was for their parents and grandparents.

Caren Maio, a millennial and a real estate professional, described that change in a recent blog: “In the span of a decade, the American Dream of homeownership has lost a good deal of its luster,” she wrote. “In its place, renting, long considered a stopgap solution, is quietly emerging as the new American choice.”

A Preference for Renting

“The forces that have given rise to renting, not to mention Uber, Airbnb and other iterations of the sharing economy, aren’t entirely economic,” Maio suggests. The millennial embrace of “no-ownership,” she says, “is also motivated by a desire to minimize environmental footprint and avoid being bogged down by an abundance of stuff we might want to use, but certainly don’t need to own. Renting fits squarely into this generational ethos.”

It is hard to know whether it is changing attitudes, financial constraints, or both that are keeping first-time buyers on the sidelines, but there is no question that they are not generating as much demand for homes as their numbers and the behavior of previous generations suggest they should be.

The national home ownership rate, reported by the Census Department, which has been declining steadily, slipped again in the final quarter of last year, to 63.7 percent, remaining well below its historical average of 65 percent. But the decline for younger buyers (under the age of 35) has been particularly steep – falling from 41 percent to 35 percent over the past 15 years. Analysts cite a combination of impediments that are currently blocking the home ownership path for first-time buyers:

Student Debt. Analysts differ on how much student loans are weighing on prospective buyers, but most agree that it has been a factor in tipping the ‘buy-or-rent’ calculation toward renting for many of them. The National Association of Realtors’ (NAR’s) most recent Home Buyer Profile reported that nearly 60 percent of non-owners who have student debt said they are not comfortable taking on a mortgage.

"In addition to having to postpone important milestones such as getting married and starting a family, many young adults are financially falling behind previous generations in part because of having to prioritize repaying their sizeable student loans over buying a home and saving for retirement," Lawrence Yun, the NAR’s chief economist, said.

Affordability. Rising rents, rising home prices and rising interest rates have created a negative trifecta for prospective buyers. Rising home prices and higher interest rates are pushing up the cost of home ownership, while rising rents are making it more difficult for first-time buyers to amass the down payment they need to qualify for a mortgage. Fitch Ratings estimates that rising interest rates over the past three months have reduced the maximum loan for which borrowers can qualify by almost 10 percent. “Many first-time home buyers have already seen their mortgage capacity eroded,” the Fitch report noted. “If rates continue to rise, particularly if they rise rapidly over a short time period, they could add yet another obstacle to homeownership.”

Lack of information. Although housing costs are keeping some buyers out of the market, mistaken assumptions about those costs are leading others to disqualify themselves unnecessarily. More than 85 percent of the buyers responding to an NAR survey said they would need a minimum down payment of 10 percent; in fact, the median down payment has averaged closer to 6 percent for the past three years, the NAR report noted.

Lack of inventory. The limited inventory of homes available, now at its lowest point in 30 years, continues to plague the market. Low- and moderately-priced homes affordable to first-time buyers have been hit particularly hard, according to Trulia, which reports that the inventory of these starter homes declined by nearly 11 percent last year, compared with a 6.5 percent dip for luxury homes.

Price pressures. Shrinking inventories are not only limiting choices for buyers; they are also putting upward pressure on home prices. The Case-Shiller home price index posted its 59th consecutive year-over-year increase in December of last year, rising by 5.6 percent. Although rising prices have improved the equity position of existing owner, pulling many out of the negative equity swamp in which they had been mired, the trend has taken a huge bite out of affordability for many prospective buyers.

The (Short) Good News Narrative

It is possible to find a good news narrative in the housing reports. Although, it is fairly short, it is impressive: More than 5.4 million single-family homes, condominiums and cooperatives were sold last year, the strongest performance since 2006, according to the NAR. New home sales also improved mightily compared with the year before, and home builders have been increasingly optimistic about the outlook for the coming year.

But despite that strong overall performance, last year did not end on a positive note. Existing home sales fell by nearly 3 percent in December, after increasing smartly in October and November, and sales of new single-family homes fell off the rails, declining by 10.4 percent to their lowest level in two years. The NAR’s pending sales gauge improved in December, but it fell below the year-ago level and threatens to remain a drag on sales this year.

Industry executives counting on new construction to ease the inventory squeeze didn’t find much cause for cheer in the new construction statistics. Although starts increased by 11.3 percent overall, all of the gain was in the multi-family sector; single-family starts declined by 4 percent in December. Single-family permits increased, but the 4.7 percent margin was hardly large enough to make anyone strike up a band.

Breathing Room for the Fed

With the spring home buying season just a couple of calendar page turns away, industry executives are focusing on the employment picture and interest rates as key indicators of what to expect. The December labor market report surprised on both the up side (the gain of 227,000 jobs was better than expected) and the down side – the pace of wage growth fell below expectations.

Analysts generally agreed that the mixed results will support the Fed’s view that additional rate hikes are indicated this year, but ease the pressure to enact them quickly.

“This buys them some breathing room,” Mark Doms, senior economist at Nomura Holdings Inc., told the Wall Street Journal. Rob Martin, an economist at Barclays, agreed, telling the Journal: “On balance, this reduces the probability of a near-term rate hike but it is not a fundamental game changer. “If you’re an FOMC member that wanted to hike in March, you can argue for that,” he added. “But if you’re an FOMC member that wants to be cautious, there is plenty of evidence for that.”

To no one’s surprise, the Fed left interest rates unchanged at its January meeting, issuing a statement that emphasized the economy’s continued improvement (reflected in the labor market, consumer spending and consumer confidence), while also noting ongoing concern about business investment, which remains soft. Analysts will be listening closely to Fed Chair Janet Yellen’s Congressional testimony Feb. 15th for a clearer indication of what the Fed is going to do — and when.