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US housing market downturn will not only weaken the growth story but also dampen inflation

Interest rates will be increased further and policy will be maintained in a restrictive range to control inflation.

US housing market downturn will not only weaken the growth story but also dampen inflation
A decline in the housing market will make the US growth narrative worse, but it's crucial to keep in mind that it will also slow inflation.

US housing recession is knocking at the door. At least this is what transpires from the housing data that is pouring in. A sharp decline in house demand is being caused by rising mortgage rates and an affordability crisis. The amount of available inventory is also increasing. The recessionary dynamics affecting the US economy will be exacerbated by a mix of declining transactions and prices.

No wonder searches for ‘real estate market crash’ exploded 284% in the United States as of September 2022 – the highest level in Google Trends history. The analysis by the Malibu real estate experts at RubyHome reveals that search interest for ‘real estate market crash’ exploded within the past month, an unprecedented increase in Americans looking for information and prognostication about the real estate market, according to Google search data.

The fundamental issue is affordability in the context of record prices and rising borrowing costs, which is why the demand momentum seems to be dissipating quickly. As of last week, the usual 30Y fixed mortgage rate was 6.52%, up from below 3% in November 2021.

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The monthly payment on a new 30Y fixed rate mortgage at the current average mortgage size and the current mortgage interest rate has increased significantly as a result of increased borrowing at higher interest rates. According to a note by the Economic and Financial Analysis Division of ING Bank N.V., “At the beginning of the pandemic, it was $1,550 a month and the average mortgage size was $350,000 at 3.4% fixed for 30 years. Based on a 30Y fixed rate mortgage for $411,700 at 6.52%, it is now over $2,600.”

As per the note, it is not surprising that mortgage applications for home purchases have decreased more than 30% year to date given that fewer people are able to save the money needed for a deposit due to inflation and declines in the value of financial assets and that even fewer people can afford the necessary monthly mortgage payments. Although it must be noted that the demand from cash buyers has decreased at a similar rate, the percentage of cash-only purchases for new homes has remained constant at 30%, this has already translated into declining new home sales.

However, due to a difficult climate brought on by a decline in demand and rising expenses, the National Association of Homebuilders Builders’ sentiment index has declined for nine straight months. They then encounter the issue that the inventory of new homes for sale has increased 64% since the third quarter of 2020 due to the slowdown in sales during a period of robust building. Prices are under pressure as builders try to sell their inventory because they are often not financially able to keep their homes vacant.

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According to the Federal Reserve’s predictions, interest rates will be increased further and policy will be maintained in a restrictive range to control inflation, therefore the housing market is likely to experience greater hardship. The US 10Y is almost at 4% and is likely to break above it, therefore we should be prepared for the 30Y fixed rate mortgage to soon get close to 7%.

A decline in the housing market will make the US growth narrative worse, but it’s crucial to keep in mind that it will also slow inflation. With a one-third weighting from the primary and owners’ equivalent rent components, shelter makes up the majority of the CPI.

It implies that the annual rate of change in these important CPI rent components may soon reach a turning point. If this is the case, consumer price inflation might be significantly reduced through 2023, which would likely help push the US inflation rate back below 2% by the end of 2023. The report says, “We are adamant that interest rate reductions will be on the table in the second half of 2023, despite the Federal Reserve’s attempts to play down the probability.”

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