February 13, 2023

Upside-down economy creates both ups and downs

The housing market and the greater economy continue to be as topsy-turvy as any time in American history.

Even as the Federal Reserve keeps trying to cool off rising inflation with higher interest rates, companies continue to hire, wages keep going up, and consumers continue to spend.

Normally, that is good news - strong employment and robust pay encourage people to keep spending, and consumer spending keeps the U.S. economy going strong.

Here is the bad news – it doesn’t really help inflation. Companies typically pass the costs of higher wages onto consumers by raising prices on the goods and services we all need.

Fed Chair Jerome Powell and the rest of the central bank's policy makers would never say it, but they would not mind if hiring slowed – for just a while. Otherwise, the soaring jobs market likely means staying the course, with further rate hikes to get inflation to a manageable level.

The trouble for the housing market is that hiking the baseline rates affects other consumer loans, with a disproportionate – and more immediate – effect on mortgages. This depresses both housing starts and private homeowner demand.

The result? Potential homeowners are driven into the rental market, increasing the price of rents while simultaneously reducing the supply of potential home buyers.

The biggest downside of all? This lower demand has not meant lower prices. Listings still have not reached the levels of two years ago and are far short of pre-pandemic levels.

So, there is half the supply as 2019, and increased pressure on homeowner prices as well as rent. Yet there are still more than enough buyers for the limited houses for sale.

It is still to be seen if all this upside-down is the result of temporary COVID-related distortions, or a lasting phenomenon driven by deep structural market changes.

There are some other upsides. While inflation is always rising, its rate appears to be slowing. With plentiful jobs, pay is still going in the right direction. In time, wages are bound to balance out with mortgage rates and listing prices, making homeownership more affordable for everyone.

But there could still be a few more ‘downs” to come. Powell acknowledged some disinflationary signals - like the slowing cost of goods -at a recent question-and-answer session. But he added it would likely be 2024 before inflation reaches the target of 2%. “It’s probably going to be bumpy…we think we’re going to need to do further rate increases,” he said.

For now, the Fed is still committed to trying to keep ahead of the economy by three or six months to accommodate the assumed lag time between its actions and the results.

Housing is one of the most weighted categories when tracking inflation, but it is also one of the most complicated to measure.

Homes usually go under contract a month or two before they close, so their most current inflation data is based on purchase decisions made earlier in the year.