New home sales are surging, home prices are rising and prospective buyers are engaging in bidding wars again. The U.S. housing market shows signs of a rebound, which will raise shelter costs and complicate the Federal Reserve’s fight against inflation.
The nascent recovery in the housing market comes sooner than expected, given that mortgage rates more than doubled in the past year and a half. But homeowners who locked in record-low rates amid the pandemic are now reluctant to sell. And that is squeezing the nation’s supply of single-family homes at the same time that a wave of millennial first-time home buyers—buoyed by strong wage growth and healthy household savings—are looking to put down roots.
That pressure is driving up demand, despite affordability issues worsened by a series of interest-rate hikes by the Fed. “We now see housing putting in a bottom, and maybe even moving up a little bit,” Fed Chairman Jerome Powell said at his June press conference.
The rebound shows up in various ways. Traffic of prospective buyers to new homes has nearly doubled in the past six months, data from the National Association of Home Builders shows. Sellers are now receiving 3.3 offers, on average, for their homes, up from 2.2 as of December, according to the National Association of Realtors. New home sales jumped 12.2% in May, while home prices have now climbed for three straight months.
Overall, it shows a housing market that is regaining momentum despite the Fed’s efforts to slow things down. It suggests that the central bank will have to raise interest rates higher and keep them elevated longer to bring annual inflation back down to the Fed’s goal of 2%.
Economists estimate housing inflation will need to fall close to 3.3% annual price growth in the CPI in order for the broader index to reach the Fed’s target. As of May, rent was at 8.7% annual growth, while the equivalent measure for owners was at 8%.
“If housing really is staging a recovery now, then we are maybe underestimating that the Fed will have to do much more to crush demand,” says Torsten Sløk, chief economist at
Apollo Global Management.
“And that, of course, is raising the bar for the Fed in terms of how much interest rates have to go up.”
The housing bounceback arrives even as Fed officials plan for a slowdown in housing inflation. While the consumer price index for rent and an equivalent measure for owners have just begun to decline in the government’s data, private sector data that captures rent costs closer to real time have shown slowing price growth since last fall.
That relief will still be arriving in the short-term. But the housing recovery has fueled concerns among central bank officials about what will happen after that. Fed Gov. Michelle Bowman said in late May that the “leveling out” in home prices “has implications for our fight to lower inflation.” And Fed Gov. Christopher Waller separately warned that the housing rebound was raising questions about how sustained that long-awaited rent relief would be.
There’s an added wrinkle. While the Fed likely would raise interest rates further to counter an insufficient slowdown in housing inflation now, doing so would have the adverse effect of exacerbating affordability issues over the long term. Rate hikes work to slow the housing market by making homebuying more expensive, thereby slowing demand, but they also make home-building more expensive—thereby dampening supply and driving up home prices in the future.
“Higher interest rates tend to discourage new construction and depress the growth of new housing supply,” says Jeff Tucker, a senior economist with
Zillow.
“So the long-term impact of trying to fight housing inflation with tighter monetary policies can really backfire.”
The risk is acute now because new builds account for a larger share of home sales, in part because fewer current homeowners are selling. While new homes typically represent 10% to15% of market inventory, they make up roughly one-third now, says Rob Dietz, chief economist for the National Association of Home Builders.
It’s too early to say exactly what the impact of higher interest rates on long-term supply issues will be, but there are warning signs. Billing at architecture firms that specialize in multifamily residences declined in May to its lowest level in two years, according to the American Institute of Architects—though that could be a natural slowdown following the record number of apartments under construction that should be finished this year.
Dietz also highlighted how tighter financial conditions now are putting pressure on acquisition and development loans, which could reduce the supply of building lots ready for construction two or three years down the road and push prices up for those that are available. “We already have tight conditions on building lots,” he says. “So this is basically taking an existing problem and making it worse.”
The upshot is that the only tool the Fed has to address its near-term housing market problem could risk making the situation worse over the long-term. But not doing enough now to tamp down housing price growth could also allow broader inflation to spiral out of control, which would carry its own set of long-term economic consequences. The Fed’s hands are tied, and the near-term challenges are likely to take priority.
“The bottom line is that rates are staying higher for longer,” Sløk of Apollo Global says. “And markets should appreciate that.”
Write to Megan Cassella at [email protected]
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