One goal of the Federal Reserve’s efforts to rein in inflation is to get the housing market “back into balance between supply and demand,” according to Fed Chair Jay Powell.
The problem? The central bank’s main inflation-fighting lever largely improves one side of the supply-and-demand equation, while potentially hurting the other.
That means the short-term moves to get home price growth under control could exacerbate the years-long trend of too few homes for sale dating back even before the pandemic.
“Certainly they’d like to see some home-price cooling. They’re starting to see falls in new home starts, which if you’re hoping for Fed policy to be having an impact, that’s a positive thing,” Andrew Patterson, senior international economist at Vanguard, told Yahoo Finance. “If you’re hoping for longer-term balance in the housing market, that may not be, because there’s been an undersupply of homes for some time.”
What is balance?
While inventory has increased as climbing mortgage rates drive out buyers, it still remains far below what’s considered healthy levels.
In a more balanced market, there’s historically a 6-month supply of existing homes, according to the National Association of Realtors, where neither the buyer nor the seller has an advantage. The figure represents how many months it would take to sell all the homes listed on the market at the current sales pace.
The current national inventory is 3.2 months, according to the National Association of Realtors, a continuation of a decade-long trend where inventory has been below that healthy level. The last time the supply hit 6 months was in September 2012. That’s pushed up prices nationwide, which accelerated during the pandemic months when the 30-year fixed mortgage rate hit historical lows and brought in a flood of buyers.
That is, until the Federal Reserve in March embarked on its most aggressive interest-rate hiking cycle in two decades as it works to tame inflation. The moves have sent the yield on the 10-year Treasury — which fixed mortgage rates track — higher.
Mortgage rates now are nearly double at the start of year around 7%, making it much more unaffordable for many buyers who have exited the market.
For instance, the volume of applications for purchases are down 41% on a year-over-year basis.
“Mortgage rates are now north of 7%, I believe [the] highest they’ve been in even a couple of decades,” Patterson said. “That’s likely to start impacting if it hasn’t already started impacting demand and start putting downward pressure on prices from the demand side.”
But the Fed’s actions are also affecting the supply side in two ways.
First, many homeowners are choosing not to sell because they don’t want to give up the lower rate they locked into over the last decade to borrow at 7% for a new home. That shrinks the number of existing for-sale homes, which typically account for more than 90% of total home sales.
Homebuilders, meanwhile, are getting more reluctant to amp up their building plans as they contend with a decline in new orders and a rise in order cancellations. For instance, D.R. Horton — the largest U.S. home builder — said canceled orders made up almost a third of gross sales in the latest quarter, versus 19% a year ago.
Falling demand isn’t the only factor affecting builders, who also face rising costs in building materials, labor, regulatory compliance, and capital.
“So the Fed can’t force home builders to build homes, right?” said Patterson. “But they can adjust interest rates that tends to impact the willingness and ability of home builders to build new homes.”
Finding the balance between low housing supply and major demand will remain a challenge for both the Fed and the housing industry, according to experts, including the would-be homebuyers now sitting on the sidelines.
“People will have to get used to the impact of higher rates,” said Chester Spatt, professor at Carnegie Mellon University’s Tepper School of Business, who doesn’t think rates are going to go “ back to where they were.”
“Those rates were artificially low, and those rates were big contributors to the inflationary problem,” he added.
Federal Reserve Chair Powell noted that some areas of the country are seeing prices decline and the latest index of home values from S&P CoreLogic Case-Shiller showed a historically fast deceleration in price growth in August — but the 13% annual increase is still high. Further slowing is likely what the Fed would like to see to help reach its inflation goal.
“Theoretically, home prices should grow at the rate of inflation. Everything should grow around 2% over the long term,” Patterson said. “Not saying that they’ll get back there but what they don’t want to see are 10% to 20% price appreciation for homes as broad as they were across the country that we saw during the pandemic.”
Dani Romero is a reporter for Yahoo Finance. Follow her on Twitter @daniromerotv
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