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Marcella Chow

Amid growing concerns about a potential US recession, housing market activity in the country – typically a reliable predictor of economic cycles and a precursor to recessions – has started to show growing signs of weakness.
Housing sales and home starts fell 13 per cent and 4 per cent in October, bringing the year-to-date decline to 28 per cent and 19 per cent respectively.
This reset has been developing over 2022, as the rapid rise in mortgage rates weighs on affordability and demand. A slowdown in the housing market will play a major role in determining the trajectory of growth, inflation and household spending within the US over the next few quarters.
A key driver behind this slowdown is the rise in mortgage rates. In tandem with the Federal Reserve raising interest rates and reducing its holding of mortgage-backed securities, the US 30-year fixed mortgage rate has risen at its highest pace in decades, from 3.1 per cent in the last week of 2021 to just under 7 per cent at the end of November.
Since housing is one of the most interest-rate-sensitive components of the US economy, there has been a drastic resetting in the housing market over the past year. High borrowing costs reduce the affordability of housing, which has led to mortgage applications dropping to their lowest in two years.
To a certain extent, this reset in housing activity was going to take place regardless of the Fed’s tightening. Covid-19 and the growing popularity of working from home saw housing activity pick up significantly in 2020, particularly as households moved from the cities back to the suburbs.

In a fashion similar to the normalisation in “excess savings” spending, it was only natural that “excess housing activity” would normalise to pre-pandemic levels.
This normalisation in housing activity, further exacerbated by higher mortgage rates, will further curb demand for housing and private investments in the near term. Based on 12 recessions since the 1940s, private investments have contributed most negatively to real gross domestic product growth during recessions, declining more than 3.2 per cent on average.
The decline in housing starts will act as a drag on private investments as residential investments fall. Given that these account for close to 20 per cent of private investments in the US, a softening in housing activity will probably lead to a meaningful slowdown in economic growth.
However, the slowdown in residential investments is unlikely to be the decisive factor in triggering a US recession, as other components within private investments, including non-residential and inventory investments, typically take a bigger hit during economic slowdowns.

On the other hand, as demand for housing declines, home prices are likely to decelerate to reasonable levels, which could have a desired easing effect on inflation. The Standard and Poor’s Case Shiller Home Price Index softened by more than 3 per cent in the third quarter of this year, and Zillow rent prices have also declined over the past few months. This should translate to a slowdown in shelter inflation, particularly as rental supply saw a modest improvement lately.
The latest October headline inflation print showed that rent and shelter prices continue to look firm but are beginning to show some signs of moderation, and it’s likely that a slowdown in housing prices will feed a further moderation in inflation, albeit with a lag.
Another concern over the sharp rise in mortgage rates is the potential increase in mortgage delinquency rates, particularly for those households on adjustable-rate mortgages. As mortgages account for over 70 per cent of existing household debt, a rise in interest payments on mortgages may put significant strain on households.
Having said that, several factors suggest that the risk of a sharp pickup in delinquency rates should be small in the US. Firstly, adjustable-rate mortgages only represent one-fifth of total mortgage loans in the US, compared to more than 50 per cent in the years before the global financial crisis.
We may not be headed for global recession gloom after all
In addition, more than 75 per cent of existing mortgages have locked in a rate of under 4 per cent. The credit quality of housing mortgages is also substantially higher and banks are well capitalised compared to 2008. A tight labour market should also support households in being able to repay their mortgages.
Looking forward, the state of the housing market will be closely monitored as it serves as a reliable barometer of the US economy. A slowdown in the housing market will weigh on economic growth but as housing and rent prices move towards an equilibrium, inflation should fall. The impact of a housing downturn on delinquency and default rates is also likely to be lower than that experienced during the great financial crisis.
Marcella Chow is a global market strategist at J.P. Morgan Asset Management


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Opinion

Business


High mortgage rates have led to a drop in house sales – but it won’t lead to anything like the subprime meltdown of the 2000s
On the upside, the drop in demand for housing could bring down prices, easing inflation



High mortgage rates have led to a drop in house sales – but it won’t lead to anything like the subprime meltdown of the 2000s. On the upside, the drop in demand for housing could bring down prices, easing inflation.


International Property

US Federal Reserve

Global Financial Crisis of 2007-2008

Macroscope

5050

Expresses the views, ideas and conclusions of the author. (Eg. Enough of Crazy Rich Asians, think of crazy poor Hongkongers.)


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