At the beginning of the year, there was much talk of the Federal Reserve cutting rates and a long-awaited recovery in residential construction.
But with resurgent inflation and rising interest rates, that recovery is not going to happen.
The traditional summer buying season will disappoint as the prevailing 30-year fixed mortgage surpassed 6.5% this week and will move higher as inflation increases and the long end of the U.S. Treasury curve rests near 5.12%.
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From my vantage point, the rate of housing completions tells me all I need to know about the state of the housing market.
Completions have declined from 1.6 million at an annualized pace in March last year to 1.37 million in March this year. Both of those figures are well below the cyclical peak of 1.82 million in April 2022.
Given that the domestic supply of housing is four million short of what is needed once one adjusts for demographic changes amid a red-hot upper-end consumer market, that figure should be materially higher.
In addition, risks around rising material and transportation costs will curtail builder sentiment and risk appetite, resulting in a ceiling on permits, starts and completions which are at the heart of the supply constraints across the domestic housing market.
The song remains the same
Housing starts dropped precipitously in 2022 and have tailed off ever since. Four years later, housing completions are falling precipitously.
The drop in the supply of new housing will only add to the housing shortage, pushing up rents and the prices of existing homes, thereby increasing the demand for and cost of a mortgage.
And because housing has a 35% share in the calculation of the consumer price index, the housing shortage is an obvious reason for increased concern for higher rates of inflation, more restrictive monetary policy and the duration of the business cycle.
For consumers, mortgage rates peaked at 8% in late 2023 and have since dropped to 6.5%. That is still the highest cost of household borrowing since the late 1990s, contributing to an inflation rate above the Federal Reserve’s 2% target for the past five years.
At the same time, the increased cost of capital for builders has added to the risk of commitment to building new housing, adding to the vicious circle of an overall housing shortage.
The takeaway
The housing shortage has contributed to the regime change in inflation rates over the past five years which now features a core personal consumption expenditures index rate of 3.2% and rising.
And because of the long-term nature of a housing shortage and the long-term nature of U.S. public-sector debt, it is unrealistic to hope for a quick solution to the housing shortage or for a lower cost of capital.
