Rate-hike fears hitting people where they live

Wednesday’s meeting of the Federal Open Market Committee is dominating all discussions. That’s inevitable. But if there’s one area where the Fed’s monetary policy could wreak changes, and where many Americans fear that it will, it is on housing.
The latest diffusion index of homebuilders’ confidence produced by the National Association of Home Builders was published.
It’s easy to see why homebuilders are getting nervous. Affordability — defined as the ability of someone on the median income to afford a median house at prevailing mortgage rates — had already dipped to its lowest level since the top of the last housing boom in 2006 by the time it was last measured at the end of the second quarter.
The housing market is a critical area where tighter monetary policy can have a big effect, with a lag. Turning to the rental market, Zillow’s index of the rate of inflation in leases taken out each month is inflating much more slowly than at the peak last fall. The bad news for the Federal Reserve, and for those thinking of renting a house, is that monthly inflation continues to be significantly greater than it was in the years before the pandemic.
This is good news for the Fed, in that it shows it’s having an impact. Now the question is whether the cure could be as bad or worse than the disease. The Absolute Strategy Research survey of investors, featured in yesterday’s Points of Return, revealed that house prices had begun to worry asset allocators, a lot.
As house prices tend to rise over time, this is startlingly bearish. It also implies rising concerns over credit. Absolute Strategy asked asset allocators how likely they thought house prices where they lived would be higher a year from now. A third thought it “very unlikely,” which the firm’s David Bowers said was “an aggressive call and suggests the tightening of monetary conditions is starting to impact an important source of collateral.’’
To be clear, this isn’t just about the US. Comparing house prices across geographies is difficult. The following chart is all in local currency terms, but it should be directionally accurate. Since the peak of the last US housing boom, US home prices have risen less than in Germany, where prices have turned downward.
There is also one other risk to monitor. Falling house prices are dangerous. Look to the London housing market as the 1980s turned into the 1990s. House prices had risen by a third in 1987, and the government in hindsight was too late to apply the brakes.
The problem became self-reinforcing. Many buyers had over-extended, taking out big mortgages in the belief that otherwise they would miss out. Once prices started to fall, they found themselves in negative equity — even if they sold the house, they wouldn’t be able to repay the mortgage. Rather than do this, they toughed it out in houses that were often too small for them, while liquidity in the market steadily dried up. Lower prices forced a negative cycle from which it took years to emerge.
Hope springs eternal and London real estate has enjoyed more booms since then. But the critical point is that the housing market affects people very directly. Living in a house that is no longer appropriate for you sucks away at your quality of life. And housing booms that put homeownership out of the reach of the youngest generation intensify inequality and injustice. As with many other aspects of the economy, it’s possible that the fallout from the pandemic may lead to an overdue reduction in the inequality that is plaguing the western world. But that might come at a high cost.
Points of Return is often criticised for a US-centric bias, which is fair enough. The US stock market is by far the biggest and the newsletter is written from New York, but there are still huge variations across the world. Things look very different outside the US. This is FTSE’s index for global stocks (both developed and emerging markets) excluding the US. The key dynamic is the interplay between the US and China, the two greatest economic powers. For more than a decade, the Chinese equity market has been prone to bubble over but had managed to stay ahead of the S&P 500, which shouldn’t be surprising given the rate of growth in the Chinese economy.

—Bloomberg