Real Estate News Week of May 8, 2023.
Home prices have bottomed nationally and in all but a few cities. The Fed raised rates for (almost certainly) the last time; now the question is how quickly they’ll have to start cutting rates if the economy begins contracting. Sellers—you can still get great prices. Buyers—watch out for the rush of demand if mortgage rates drop further.
First Republic Bank collapsed and was purchased by JP Morgan. That’s three big bankruptcies for the ‘sound and resilient’ sector. The total assets of Silicon Valley Bank, Signature Bank and First Republic Bank at end-2020 were roughly $530 billion, equivalent to ~2% of total commercial bank assets.
According to an analysis by the New York Times, that $530 billion is already greater than the total (inflation-adjusted) assets of the 25 banks that went belly-up during the Global Financial Crisis. Hmmm. [New York Times]
Despite this, the Fed lifted short-term interest rates by 25 bps (one-quarter of one percent) on Wednesday, bringing the total increase to 500 bps (that’s 5%) over 14 months. While Fed Chair Jerome Powell refused to say ‘pause’, the language elsewhere suggested this was likely.
The Fed futures market, by the way, is looking way past the ‘pause’ and pricing in 3 cuts before the end of the year! That’s why the yields on mortgage-backed securities (and the mortgage rates offered by lenders) had a big move lower over the last few days.
According to the JOLTs report, the number of job openings dropped by 375,000 in March to a two-year low of 9.6 million. To put that in perspective, the number of job openings in March 2022 (the peak) was 12.0 million and in February 2020 (just prior to COVID) was 7.0 million. [BLS]
But then a day later, the ADP National Employment Report showed that private employers added 296,000 jobs in April, much higher than expectations and the largest increase since July 2022. Annual wage growth, however, slowed to 6.7% in April, from 6.9% in March and the peak of 7.8% in September 2022. [ADP]
CoreLogic’s latest Home Price Insights reported that national home prices had risen by 1.6% MoM in March (accelerating from +0.8% MoM in February). The company now expects national home prices to rise 4.6% over the next 12 months (last month’s forecast was 3.7%). [CoreLogic]
Black Knight’s Home Price Index had national home prices increasing for the 3rd-straight month (+0.5% MoM in March). While there are several markets with median prices down 10–15% from their mid-2022 peak, only Austin, Salt Lake City and San Antonio are still seeing prices declining MoM on a seasonally-adjusted basis. [Black Knight]
What the Fed Did and Said
Another +25 bps. No surprise, but still ill-advised. Remarkably, Fed Chairman Jerome Powell refused to say (definitively) that they would pause from here. Instead, they dropped the language about (perhaps) needing more rate hikes from here: “Some additional policy firming may be appropriate.”
Look at the blue line in the chart below—that’s inflation (headline CPI). You don’t have to be a statistician to identify the trend. Despite this, and the ongoing banking system shocks (3 bankruptcies so far, and a lot of savage stock price drops), the Fed raised rates again.
So…in 14 months, the Fed has raised rates 10 times for a total of +500 bps (that’s 5%). The orange line in the chart below makes it very clear that: 1) the Fed kept rates at zero for far too long, even as inflation rushed higher, and 2) that the ‘data-dependent’ Fed seems to be ignoring the significant progress already made on inflation.
By the way, have you seen oil prices lately? WTI at $69/barrel despite OPEC production cuts! WTI was at $120/barrel eleven months ago—in June 2022, which not coincidentally is when CPI headline inflation peaked.
Why We Want a Recession
People lose their jobs in recessions. The stock market goes down and retirement portfolios get whacked in recessions. Companies go bankrupt in recessions. So are we just being heartless when we eagerly await the economy contracting? Not at all. Let me explain.
We’ve got three, big problems in residential real estate right now: high mortgage rates, a limited supply of existing homes for sales, and low affordability. In fact, all three problems are related because high mortgage rates are discouraging would-be sellers (they don’t want to give up their 3.5% mortgage and take on a 6.5% one) AND keeping monthly mortgage payments high.
So how do we get mortgage rates down? We get inflation down. The Federal Reserve has made it very clear that it will not relent until it sees inflation much lower and the job market loosening up (the unemployment rate starting to rise).
If and when the economy begins contracting, the Fed will realize that it has done too much. It knows, of course, that recessions are deflationary. Rate hikes will be over, and rate cuts won’t be far behind. Look at the long-term chart for the Federal Funds effective rate below. The Fed embarks on a tightening cycle and a recession follows—usually not long after the Fed ‘pauses’.
It doesn’t have to be a big recession. Just enough for the labor market to loosen up a bit and the Fed to start cutting rates. Mortgage rates will move lower, fewer would-be sellers will feel ‘locked-in’ by low existing mortgage rates, and inventory levels and new buyer affordability will improve. Then, and only then, will the residential housing market start to feel normal again.
Recession myth-busting
MYTH: Home prices crash during a recession.
TRUTH: Looking at 9 recessions over the last 60 years, home prices only crashed once—in 2007/2008.
If you’ve been reading Talking Points regularly, you know that national home prices have already started increasing month-over-month.
- Case-Shiller: +0.2% MoM in February [now down just 2.8% from its June 2022 peak]
- FHFA: +0.2% MoM in January, +0.4% MoM in February
- CoreLogic HPI: +0.8% MoM in February, +1.6% MoM in March
- Black Knight HPI: +0.1% MoM in January, +0.4% MoM in February, +0.5% MoM in March
MYTH: You can’t have a recession with the unemployment rate near record lows.
TRUTH: Most recessions start with very low unemployment rates.
The gray bars indicate recessions. Notice the pattern? Low unemployment doesn’t stop recessions from happening. Instead, it is the recession that causes unemployment levels to rise!
Mortgage Market
Remember, the Fed doesn’t set mortgage rates. That’s determined by supply and demand in the mortgage-backed securities market and lenders’ margin requirements. That said, the Federal Funds Rate is effectively the ‘risk-free rate’ relative to which all other (riskier) fixed-income securities are priced.
For the most part, ‘a rising tide [Fed funds rate] lifts all boats [yields on MBS and rates on mortgages]’, but it isn’t always the case, especially at turning points. This week is a perfect example: the Fed raised rates +25 bps, but mortgage rates dropped!
The Federal Funds Rate is the rate today; but government bond and MBS prices predict the future. And the future—according to the futures market :)—is rate cuts.
They Said It
“The slowdown in pay growth gives the clearest signal of what’s going on in the labor market right now. Employers are hiring aggressively while holding pay gains in check as workers come off the sidelines. Our data also shows fewer people are switching jobs.”—Nela Richardson, ADP Chief Economist
“The latest interest rate hike by the Federal Reserve is unnecessary and harmful. Consumer price inflation has been decelerating and will continue this trend. After the awful 9% consumer price inflation in the summer of last year, the latest data shows 5% inflation. It will be even lower as the heavyweight component to inflation, which is housing rent, will inevitably slow down given the 40-year high robust construction of new empty apartment units.”—Lawrence Yun, NAR Chief Economist
