NAHB: Keeping an eye on rising rates

(A market analysis by NAHB Chief Economist Robert Dietz, originally published at: NAHB.com)

rising interest ratesRising interest rates and declining home affordability are the main culprits for continued weakness in home sales and home starts in recent months.

Since the start of 2022, the benchmark 10-year Treasury rate, which often moves along with mortgage rates, has risen from 1.51% to around 3.7%. The average 30-year fixed mortgage rate, as measured by Freddie Mac, has risen even more, from 3.11% at the start of the year to 6.7%. Coupled with higher construction costs and rising house prices, these market dynamics have pushed home affordability to more than a decade of lows.

Builders’ confidence in the single-family housing market closely reflects deteriorating affordability conditions, which have declined for nine consecutive months, as recorded by the NAHB/Wells Fargo Housing Market Index (HMI).

As the NAHB economics team closely monitored housing market conditions, NAHB led the way with other market analysts when we reviewed the single-family market facing an inflection point as interest rates rose. And in August, NAHB’s HMI lecture prompted our economists to give a “housing recession”— and other major news outlets and economists soon followed suit in describing the weakening housing market.

Reasons for the rapid rise in rates

The economic drivers of these conditions are a nearly 40-year inflation caused by too much COVID-era stimulus, supply chain problems and global market disruptions, including Russia’s war on Ukraine. While the Federal Reserve is now aggressively tightening monetary policy, through higher short-term interest rates and balance sheet reductions that ultimately amount to tens of billions of dollars in assets from its massive nearly $9 trillion bond portfolio, it waited too long to act.

The central bank’s call last year that inflation was “transient” was a prediction error. The situation was further exacerbated by the failure at the local, state and national levels to properly and effectively address the supply side of the economy, where inflation can be combated more efficiently. With the Fed falling behind the inflation curve, its leadership has now taken a grim, aggressive stance to convince the markets that it is in the inflation war to win.

As a result of the Fed’s aggressive monetary policy stance, interest rates have risen significantly in 2022 and especially in recent weeks. Since early August, the 10-year Treasury rate has risen from 2.6% to about 3.7%. And while the bond market decline accelerated this week (a falling bond market often means rising mortgage rates), the 10-year Treasury rate briefly rose above 4%, its highest rate in 15 years. Thereafter, yields fell amid global concerns and a focus on macroeconomic weakness at the end of the week.

In addition, mortgage interest rates have become much higher as the spread between the 10-year Treasury and the 30-year fixed-rate mortgage has widened due to market uncertainty, the risk of prepayment of mortgages and the Fed’s plan to raise tens of billions of dollars. of mortgage-backed securities to roll off the balance sheet each month.

The prospects for the future

The consequences of this credit market are clear to builders. Buyers are priced out of the market, especially first-time buyers. Profit margins under pressure from housing market costs are under pressure from the need to adjust prices and incentives to attract buyers. And a housing market that needs more supply to address a significant, structural housing shortage of about 1 million homes must put this long-term project on hold as real-time market demand, weakened by declining housing affordability, retreats.

Given this macroeconomic environment, 2022 will be the first year since 2011 that the start of construction of single-family homes will decline. The housing market and other elements of the economy are clearly slowing down. The Fed, which many market observers believe has now taken an overly aggressive stance, should focus on year-end inflation data and slow down its tightening path to see if its policies are working to curb inflation. .

And other regulatory and fiscal policymakers must do what they can to reduce the cost of regulation and other ineffective rules that artificially increase the cost of remodeling homes, building apartments, and supplying rental and owner-occupied housing to the market.

In the meantime, builders should remain cautious with the operations. The Fed has indicated that it intends to keep interest rates high for longer. Unless a severe recession hits in 2023, interest rates are unlikely to fall until 2024. At that point, however, the housing market will pick up again as interest rates fall and a group of frustrated potential homebuyers return to the market to a greater extent. numbers. Unfortunately, this means home ownership will decline in 2023, putting housing firmly on the political agenda in the run-up to the 2024 elections.

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