Monetary Policy & Inflation | US
- The residential real estate market is returning to pre-pandemic trends.
- Very low vacancy rates and inventory, with unfinished housing in line with historical norms, suggest an impending crash is unlikely.
- However, the Fed has no choice but to engineer a sharp real estate slowdown to realign aggregate demand with aggregate supply and stabilize inflation.
- The Fed will likely have to hike interest rates more than the market expects to tame the housing market and inflation. We expect rates could go as high as 8%.
Residential Investment Is About to Slow…
In line with the rest of the US economy, the residential real estate market is normalizing.
Residential investment, proxied by Census Bureau monthly construction spending data, has not slowed yet. However, key drivers are returning to pre-pandemic levels (Chart 1). These include new home sales, housing starts and the NAHB index (which averages actual and expected home sales and foot traffic).
And residential investment will likely follow indicators such as new home sales, with which it has been historically correlated.
But the Residential Real Estate Market Is Not About to Collapse
Residential investment may be about to slow, but the real estate market is not on the brink of collapse. Vacancy rates for owned homes are the lowest since the 1950s and for rented homes are near series lows. This contrasts, for instance, the surge in vacancy rates ahead of the GFC (Chart 2).
Inventories of new houses (i.e., new houses available for sale) recently increased back to pre-pandemic levels (Chart 3). Existing home inventories, however, remain at a historical low. The latter are a better indicator of market pressures than the former since existing home sales are about six and a half times as large as new home sales.
Finally, nothing indicates an impending surge in housing supply. Housing starts and houses under construction are back to pre-pandemic levels. Also, averaged over two years, homes completed remain well below pandemic levels, which likely reflects continued supply-side issues.
Overall, low vacancy rates, low inventories, and no signs of fresh supply will prevent an imminent collapse.
How Will Real Estate Impact Economic Growth?
The real estate market impacts growth through two main channels: residential investment and household wealth. As we saw, real estate investment is likely to slow, but not collapse. Meanwhile, house price growth is starting to slow, which will impact household wealth.
Residential real estate assets represent about a fourth of median household total assets. A decline in real estate prices would therefore negatively impact household wealth. However, the impact on consumption is uncertain for two reasons.
First, a downturn in real estate prices could take time to materialize. A rebuild of inventories, which are strongly and negatively correlated with prices, could take several quarters (Chart 4). Household leverage has been stable, and investment has been in line with historical norms, suggesting less of a downturn and possibly no decline in the level of prices.
Second, since the GFC, the household savings rate has become unresponsive to changes in wealth. That is, a decline in wealth may have little impact, on its own, on consumption.
Overall, the real estate market on its own seems unlikely to bring GDP growth below potential. Yet residential investment is one of the few interest rate sensitive components of demand (the other is consumer durables). The Fed has therefore no choice but to engineer a sharp real estate slowdown to realign aggregate demand with aggregate supply and stabilize inflation.
The bottom line remains that the Fed is likely to hike by more than the market expects. The rate cuts priced by the market starting January 2023 appear unlikely. To the contrary, worse-than-expected inflation dynamics are likely to see the Fed lift its terminal FFR and eventually publish a SEP showing a terminal FFR near 8% – together with a large increase in unemployment.
Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)