Housing Ripples - June 26, 2018
As the Global Financial Crisis made glaringly apparent, ‘as goes the US housing market, so goes the overall U.S. economy’. It is therefore unsurprising that not only is it on our radar but it’s also a favorite of the Fed. Housing prices, like the stock market, are an integral part of the wealth effect theory. The theory goes that as homeowners see their house price rise, they feel cash-flush and are inspired to spend. Amongst the FOMC, Atlanta’s Raphael Bostic is intimately familiar with this dynamic, having published a paper in January 2007 discussing the relationship between housing prices and personal consumption. In it he found that from 2001 to 2005, increasing real estate wealth accounted for more than 12% of the growth in personal consumption expenditure, or 9% of U.S. GDP growth during the same period. However, as the paper notes, the wealth effect is a double-edged sword:
“Those same computations suggest the possibility of sizable reverse wealth effects in the context of a retrenchment in house values.”
Hence, it is interesting that some of the data, that would fall under the broader category of shelter, looks to be losing a little momentum. For example, the latest Case-Shiller Home Price Index reading of 6.56% YoY was slightly below expectation. This is a similar pattern to what we saw with Existing Home Sales and Building Permits, which is normally considered a leading indicator for construction. On a local basis, it’s also interesting that what had been some of the hottest markets up until recently, are seeing significant softness. For example, this article on the Seattle rental market discussed how, with supply finally catching up to demand, landlords are offering everything from free months to Amazon gift cards. Similar dynamics are also visible in certain markets in New York.
However, it’s not all bad, with this week’s New Home Sales surprising to the upside. Thus, as one might expect, the home builders remain upbeat as illustrated by these comments from Lennar, one of the US’s largest home construction companies:
"[S]trong results were supported by continued solid fundamentals in the housing market... Concerns about rising interest rates and construction costs have been offset by low unemployment and increasing wages, combined with short supply based on years of underproduction of new homes.”
What’s more, and as we’ve said before, above and beyond the pure data, the impact of the sector on the broad economy can be profound. For example, while homeowners may be inspired by higher house prices to open the spending spigots, not everyone is so pleased about shelter inflation. For example, according to a Bloomberg article (monthly article limit), later this week, research from Dean Baker at the Center for Economic and Policy Research will be presented to Atlanta Fed’s Bostic, looking specifically at the outsized role of shelter costs in determining Core PCE. What Baker states is that,
“If shelter costs are removed from core measures of inflation there is zero evidence of any acceleration in the inflation rate”.
Adding that, “the rapid pace of increase in shelter costs is not due to rising construction costs, but rather due to restrictive zoning practices in a limited number of highly desirable metropolitan areas that have limited the supply of housing”.
Bottom line, the Fed needs to be careful they don’t overtighten.