NAHB Chief Economist Robert Dietz recently provided the following economic and housing industry overview in his bi-weekly newsletter Eye on the Economy.
During the month of August, long-term interest rates increased quickly, with the 10-year Treasury rate rising from 4% to 4.35%. This move was generated by an increasing supply of bonds, ongoing reductions of Fed holdings of Treasuries and mortgage-backed securities (quantitative tightening), renewed hawkish commentary from Federal Reserve officials, and a slight uptick for the CPI measure of inflation.
The result was an increase on rates for both builder loans and mortgages, with Freddie Mac reporting an average rate of 7.23% for the 30-year mortgage, the highest level since 2001. The recent gain proved wrong an earlier NAHB forecast that rates for this monetary policy cycle would peak back in the fall of 2022.
However, interest rates have moved lower since late August as additional data points indicate cooling consistent with some disinflation. The 10-year Treasury rate moved below 4.2% as labor market data indicated declines for the total number of job openings for the U.S. economy (falling below 9 million in July) and the construction sector (363,000 in July).
These estimates align with a slowing economy brought on by tighter monetary policy. This data should convince Fed hawks that now is the time to pause and let current restrictive monetary policy finish the job. The Fed should want to avoid tightening too much, which is now the greater risk.
Prior to the move in August, higher interest rates were having a slowing effect on the housing market. Total existing home sales fell 2.2% to a seasonally adjusted annual rate of 4.07 million in July per the National Association of Realtors. On a year-over-year basis, sales are 16.6% lower than a year ago. In part, this decline is because of a lack of inventory (just a 3.2-month supply) resulting from the mortgage rate lock-in effect. The vast majority of home owners with a mortgage have an existing note of less than 5% and would prefer to hold such a low rate.
Despite a multi-decade low for housing affordability, the lack of existing inventory is spurring more demand for new construction. Sales of newly built, single-family homes in July increased 4.4% to a 714,000 seasonally adjusted annual rate. The pace of new home sales in July was up 31.5% from a year ago. In terms of overall inventory, new construction is now 31% of the market, compared to 10% to 15% historically.
Builders have helped attract sales via mortgage buy-downs and other sales incentives, but also via product shifts. For example, new home size continues to fall, reaching a decade low (2,415 square feet) in the second quarter. Consequently, median prices for new single-family homes are down almost 9% from a year ago to just under $437,000. Declining demand for larger houses also reduced custom home building starts in the second quarter, which were down 8% year over year to 189,000 total homes over the past year.
Eventually, the Fed will ease rates. Just about 90% of consumer inflation in July was because of rising shelter costs, and real-time measures of rent show a slowdown. As inflation moves lower (even if it is still above the Fed’s 2% target), the necessary inflation-adjusted restrictive interest rate required to reduce inflation will decrease, allowing the Fed to cut the federal funds rate. This will likely occur no later than mid-year 2024.
In the meantime, elevated rates for financing for AD&C loans mean that lot supply will be too low as a housing market recovery builds momentum in 2024.