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Capital Comments: The Housing Market is Cooling Off

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The Federal Reserve is serious about battling inflation. They’ve raised their policy interest rate from near zero in February to an average of 2.33 percent in August. Earlier this week they raised it another three-quarters of a point, the first time it’s been above 3 percent since early 2008.

The idea is to get people to borrow less, so they’ll spend less, so businesses have less reason to raise prices. Not much has happened to inflation yet – except in the housing market. That’s no surprise. Most houses are bought with mortgages, so if borrowing is more expensive, fewer people will buy houses. 

The average interest rate on 30-year mortgages has increased with the Fed’s policy efforts, from 3.8 percent in February to 6.3 percent by mid-September. That rate increase would cause the monthly payment on a 30-year, $200,000 mortgage to rise by more than $300 a month, almost $4,000 a year. That’s enough to discourage quite a few homebuyers, which is the point of the Fed’s policy.

The U.S. Census provides a nice measure of the condition of the housing market, called the “Monthly Supply of New Houses.” The calculation starts with the number of new houses for sale during the month. It was 464,000 in July. They measure the number of new houses sold in the month, 42,600 in July. Then they divide the number for sale by the number sold. The result is the number of months that the supply of housing would last, if sales continued at the monthly rate.  In July, 464,000 divided by 42,600 was 10.9 months. 

That single number is a clue to the state of housing supply and demand. The number of houses for sale is the supply. The rate at which people are buying those houses is the demand. Divide the supply number by the demand number, and you’ve measured the temperature of the housing market. A big number means that a lot of houses are for sale, compared to how many people want to buy. The market is cold. A small number means houses are scarce compared to demand, so the market is hot. 

Supply and demand should affect price. In a hot market, when demand is high and supply is low, prices should rise. In a cold market, prices should fall. 

“Hot” describes the housing market in recent years. The monthly supply averaged 5.6 months from 2016 through 2019, and the median price of a new house rose 3.3 percent per year. When COVID came along the drop in home building limited supply for a few months. But demand jumped. Mortgage rates fell, incomes rose with federal COVID aid, and people wanted more room. The monthly supply dropped to 3.3 months in August 2020, the lowest reading in the 59-year history of the measure. The median house price rose 15 percent in 2021. The market was blazing hot.

Now the market is cooling, fast. Monthly supply was 5.6 months in December. By July it was 10.9 months, the highest number since March 2009, during the housing crash of the Great Recession. Back then it took 25 months for the monthly supply to rise from below 6 to above 10 months. This time it took 7 months. That’s fast. The median house price has dropped 4 percent since April. It’s likely to fall more.

Home building is falling too. If supply exceeds demand, and prices are falling, there is less reason to build new houses. Housing starts have dropped 13 percent since April, even with the unexpected increase in August. Building permits are down 17 percent, which means even less home building in the next few months.

If fewer homes are built, there’s less demand for building materials. Lumber prices have fallen 30 percent since March. The demand for new appliances and furniture falls. Appliance prices are down 3 percent since March, though furniture prices are rising, for now. 

Unfortunately, if fewer homes are built, fewer construction workers are likely to be employed. Appliance makers may cut hiring or lay off employees. The labor market is so strong that other jobs may be available, but if not, these families will reduce their spending. 

Inflation will fall, but it comes with a cost.

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