Housing activity is showing minimal effects from the sharp rise in mortgage interest rates. That could complicate the Federal Reserve’s task of reining in galloping inflation.
New housing starts increased 0.3% to a seasonally adjusted annual rate of 1.793 million units in March, the Commerce Department reported Tuesday. That is on top of upward revisions of 41,000 in the two preceding months and contrary to projections of a slight dip to a 1.74 million pace. The gains this past month were in the multifamily category, which was up 4.6%, while single-family starts were off by 1.7%.
The starts data don’t tell the whole housing story, however. The backlog of houses under construction and the large number that has been authorized but hasn’t broken ground means home builders will remain busy through the year. That will keep the economy growing but also may continue to put upward pressure on prices, contrary to the Fed’s efforts to cool things off.
There was a time the Fed could regulate the economy by virtually turning housing off and on like a tap by manipulating interest rates. That relationship broke down during the housing bubble of the early 2000s, as home-building went wild even though the central bank raised its key federal-funds target rate 17 times in one-quarter percentage-point increments, to 5.25%.
So far, the Fed has raised its funds rate once, by a quarter-point, to a range of just 0.25%-0.50%. But 30-year fixed-rate mortgages have soared from just over 3% at the turn of the year to over 5%. Much of that jump has come in recent weeks; in early March, long-term mortgage rates were still under the 4% mark. Clearly, the market is anticipating the Fed’s future tightening moves, including half-point hikes in the fed-funds targets at its May 3-4 and June 14-15 policy meetings, plus a reduction in the central bank’s mortgage-backed securities holdings.
The surge in borrowing costs surely will deter some prospective homebuyers who already have been coping with soaring house prices, which were up over 19% in the 12 months through January in the most recent S&P CoreLogic Case-Shiller national data. Some of the sting of higher mortgage rates can be eased by borrowers opting for adjustable-rate loans, which still are available with rates under 4%.
If higher mortgage rates ration demand for new homes, builders may hardly notice. The number of units under construction continues to climb at a rapid pace, according to a note from Jefferies economists Aneta Markowska and Thomas Simons. At a 1.7 million annual rate, that tops even the bubble frenzy year of 2006, when there were 1.5 million units under construction at the peak.
“This suggests existing projects are taking even longer to complete, likely a result of continued labor and product shortages. This has the effect of stretching out the housing cycle, pushing construction further into the futures and smoothing through the volatility in end demand,” they wrote.
Meanwhile, the National Association of Home Builders reported Monday that its housing market index inched down two points in April, to a still strong reading of 77. It was hurt by a downtick in current sales and traffic from prospective buyers, but the outlook for future sales improved. Similarly, Evercore ISI’s proprietary home builders survey also dropped in its latest reading but remained elevated at levels near the bubble years early in the century.
Much of the current building activity has moved to multifamily units in response to surging rents. The main casualty of any slowdown in the housing sector will likely be broker commissions, Markowska and Simons add. The supply of existing homes for sale remains tight and may remain so. Homeowners looking to trade up may be discouraged by having to swap their current low-rate mortgage for a considerably pricier loan on a new property.
Still, home builders have never been busier with their current backlog. Their stocks, in contrast to their business, appear priced for recession. As Barron’s Andrew Bary recently wrote, home builders are the cheapest group in the market and trade below their liquidation values based on the economic value of their landholdings, which are higher than the conservative marks on their balance sheets.
For the Fed, the continuing strength of home-building, both single- and multifamily, represents a challenge. The only way to wring out inflation is to slow the economy. A 5% mortgage rate is negative in real terms, whether measured against the 8.5% 12-month rise in the consumer price index or especially compared to the near-20% jump in house prices. Negative interest rates spur rather than deter borrowing.
Some prospective home buyers might be priced out of the market by higher mortgage rates and house prices during this spring selling season. But home builders have a huge backlog of houses under construction and more than have been permitted but not yet started. This key cyclical sector of the economy remains more constrained by supply than demand, a complication for the central bank’s anti-inflation efforts. Write to Randall W. Forsyth at email@example.com
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Article Retrieved from Market Watch