Federal Reserve Continues to Push Against Inflation but the Labor Market Is Pushing Back

Two months into the new year, consumers are spending less, economic growth has slowed, the inflation rate has declined (although arguably not as much as the Fed would like), and the over-heated housing market has cooled.

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We talk about inflection points, moments in time when significant changes can fundamentally alter established personal, political or economic norms.  We may be approaching just such a point in the housing market, where the seemingly inexorable upward trend in home prices may be reversed, where the ‘balance of power’ may be shifting from sellers to byers, and where a significant “correction’ may already be under way.

Rising interest rates – a byproduct of the Federal Reserve’s continuing battle to tame inflation – are a major driver of these changes.  With the Fed’s third consecutive 0.75 percent increase in its benchmark fed funds rate (and the promise of more increases to come), mortgage rates are now approaching 7 percent – up a full percentage point since September 1 and more than double the year-ago rate of about 3 percent.

Not surprisingly, higher interest rates have curtailed mortgage demand.  The Mortgage Bankers Association (MBA) reports that loan applications have declined in six of the past seven weeks, while refi applications are now 84 percent  below where they were a year ago.  Compounding this negative trend, lenders are ratcheting up their underwriting guidelines, pushing credit availability to its lowest level in almost 10 years, according to the MBA.  

Housing Market ‘Correction’

Housing industry analysts, who have been predicting a “correction,” say it is now well under way, with existing home sales, new home sales and single-family construction all trending steadily downward. Existing home sales fell for the seventh consecutive month in August – the longest series of month-over-month declines since 2008.  New home sales actually jumped in August, but analysts say the nearly 30 percent increase was an aberration caused by buyers anxious to close deals in advance of future rate hikes, and builders slashing purchase prices in the face of declining buyer demand.  

“Long story short,” an article in Mortgage News Daily explained, “rate momentum created opportunity…and then urgency [for buyers].  At the same time, builders [concerned about rising inventories of unsold homes] were looking to wheel and deal on both price and rate.  The net effect was likely a one-off [jump in new home sales],” the article suggested, “and should [not] be construed as evidence  of a turning point for the housing market’s challenges.”

The August increase in new home sales  did nothing to improve builder confidence, which declined for the ninth consecutive month in September, falling to the lowest level in more than two years, the National Association of Home Builders (NAHB) reported. 

Home prices continue to rise, but more slowly.  Seasonal factors usually ease price pressures in June and July, but the decline in existing home prices this year was three times the historical average, according to the National Association of Realtors.  The closely watched Case Shiller national home price index increased at a 15.8 percent annual rate in July – well below the 18.1 percent rate reported in June.

Negative Pressures

 market conditions are creating negative pressures for both buyers and sellers.  Rising rates and higher home prices (rising more slowly but still higher than they were a year ago) are making housing less affordable, forcing many buyers out of the market.  Growing fears of a recession – which Federal Reserve officials have indicated is both a possible and an acceptable byproduct of their efforts to combat inflation are undermining buyer confidence in the economy and in their own financial security. Fannie Mae’s monthly index of buyer confidence in the housing market declined in August to the lowest level since 2011.

 “To make the biggest  financial decision of your life, you need to have some confidence in the economy, in your job, and in the labor market,” Odeta Kushi, deputy chief economist at First American Financial told the Wall Street Journal. 

Selling a home also requires confidence, both in buyer demand (which is shrinking) and in the prospect of finding a desirable and affordable replacement home, also less certain given still skimpy inventories.  Rising interest rates have created an additional disincentive for sellers, who are reluctant to exchange their current  mortgage rates for rates that may be twice as high. 

Although analysts say most markets continue to favor sellers, many also see evidence that the balance of power has begun to shift in favor of buyers.  “After the frantic rush for real estate over the past two years, buyers are finally seeing a calmer market,” Nicole Bachaud, a senior economist at Zillow, observes in a recent report. Affordability pressures are keeping many would-be buyer son the sidelines, she acknowledges, but buyers who are able to afford homeownership costs “are quickly regaining lost leverage.” The shift from seller to buyer control is still in its early stages,” she notes, but it is coming.