Double Down?

“Money often costs too much.”
Ralph Waldo Emerson

Question:  Will higher interest rates slow down the housing market and the economy?

Answer: The housing market is a key component of the US economy with potential spillover impact to other economic sectors. Interest rates are up in efforts to slow the economy after record breaking monetary expansion during the pandemic. While it’s a priority for the Fed to bring down inflation by raising rates, it is imperative to consider that the repercussions of a declining housing market extend well beyond home prices.

Mortgage rates have more than doubled from approximately 3% to over 7% today. Existing home prices are up 8.4% year-over-year and the same mortgage costs roughly $1,000 more per month than it did one year ago. The combination between higher mortgage rates and higher home prices has slowed the housing market. The slowdown is good news for the Fed as this is a sign that its strategy of targeting long-term interest rates (mortgage rates) to slow the overall economy is working.

Home prices do not enter the Consumer Price Index (CPI) calculation, but the services provided by housing do, either in terms of rent or carrying costs, and account for almost one-third if the inflation indicator. As rates go up, home prices tend to go down, putting pressure on rental rates to go lower too. This process historically takes six to twelve months to take place and materialize in changes to monetary policy. Once prices start to decline, the shelter component of CPI should show some relieve, ultimately contributing to lower headline inflation reports.

From an economic perspective, the National Association of Home Builders shows that construction, remodeling, and broker’s fees historically made up 3-5% of Gross Domestic Production (GDP). The largest impact on GDP comes from consumption spending on housing services which averages 12-13% of GDP. These items include rents, owner’s carrying costs, and utilities. The direct and indirect effects of housing for the US economy represent about 15-18% of GDP. The decline we’re starting to see in the housing market will likely have a large impact on the overall economy.

There are many additional costs associated with buying a home, such as closing fees, appraisals, and inspection costs. One the home is purchased there are ongoing expenses in addition to a mortgage that include insurance, taxes, maintenance, and more personalized costs for decorating and furnishings which ultimately impacts other businesses.

Housing market date shows a weaking pace for existing home sales and home prices but not a collapse. US home sales continue to cool down according to the National Association of Realtors. Sales were very close to markets estimates at 4.71 million with the median home price of existing homes still above last year’s median price. Multi-family home sales are booming showing a very different story predicated on affordability in a weakening economic environment.

Leading Economic Indicators (LEI) continue to point to a weakening US economy. This is expected to remain a trend in the coming months as higher interest rates weigh on the strength of the US labor market. The Conference Board LEI Index declined 0.40% in September to 115.9 after being unchanged in August. This is the seventh month-over-month decline for the LEI Index this year. The Fed’s rapid pace tightening of monetary policy is expected to continue to slow down the economy. Consumers are still spending but are more discriminating with their purchases, balking at higher prices. Stay focused and plan accordingly.

Data Source: FactSet, as of 10/20/2022

The opinions expressed are those of the writer as of October 23, 2022, but not necessarily those of Raymond James and Associates, and subject to change at any time based on market conditions and other factors. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. Investing involves risk and the possible loss of principal invested, investors may incur a profit or a loss. There is no guarantee any particular investment strategy will be successful. Past performance is no guarantee of future results. Changes in tax laws or regulations may occur at any time and could substantially impact your situation. Raymond James financial advisors do not render advice on tax or legal matters. You should discuss any tax or legal matters with the appropriate professional.