Goldman Sachs "Will Higher Rates Put Out the Housing Fire?"

Will the Fed have to Hike Rates more than currently expected?

Goldman Sachs economist Ronnie Walker put out a research note this morning titled: “Will Higher Rates Put Out the Housing Fire?"

Walker discusses the recent sharp increase in mortgage rates and writes:

“Standard economic models suggest that an increase of that magnitude should weigh substantially on housing, the most interest rate-sensitive segment of the economy and the textbook channel of monetary policy transmission.”

Last month, in Housing, the Fed, Interest Rates and Inflation, I noted that housing is a key transmission mechanism for Fed policy. However, Walker argues that

“the extreme supply-demand imbalance in today’s housing market will likely dampen the hit to activity from higher rates”.

This is critical, and if correct, may suggest the Fed will have to hike rates more than expected. Along these lines, over the weekend, Nick Timiraos at the WSJ tweeted:

Nick Timiraos @NickTimiraos

High levels of all-cash sales and investor purchases may make housing markets more resilient to a big run-up in mortgage rates that is depriving shocked buyers of purchasing power wsj.com/articles/decad…

And I responded:

Bill McBride @calculatedrisk

@NickTimiraos The new conundrum: The Fed’s primary channel of policy transmission is housing. The more resilient housing is to rates, the more the Fed will have to hike to cool embedded inflation.

Walker forecasts:

• Existing home sales will decline in 2022: “We expect existing home sales to total 5.8mn in 2022 (a 6% decline from the 2021Q4 pace)”

• Housing starts will increase in 2022: “We also find that housing starts have historically been unresponsive to changes in mortgage rates in a supply-constrained environment … That finding supports our strategists’ expectation that housing starts will total 1.7mn this year (a 5% increase vs. 2021).”

• House price increases will slow, but will still be robust in 2022: “we estimate that the current tightness of the housing market and blistering near-term momentum will support just over 10% home price growth this year (Q4/Q4)”

My sense is housing activity will slow, including housing starts. Previous periods of rising rates showed declines in housing starts, although - as Walker notes - the current supply constraints might “dampen” the downside for housing starts.

On house prices, we only have Case-Shiller and FHFA data through January (and CoreLogic data through February), but it appears house prices increased sharply in Q1 of 2022. So, a 10% increase, Q4/Q4, would suggest a significant slowdown in house price increases for the remainder of 2022.

The NAHB reported this morning: Housing Market at Inflection Point as Builder Confidence Continues to Fall

Rapidly rising interest rates combined with ongoing home price increases and higher construction costs continue to take a toll on builder confidence and housing affordability.

Builder confidence in the market for newly built single-family homes moved two points lower to 77 in April, according to the National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index (HMI) released today. This is the fourth straight month that builder sentiment has declined.

“Despite low existing inventory, builders report sales traffic and current sales conditions have declined to their lowest points since last summer as a sharp jump in mortgage rates and persistent supply chain disruptions continue to unsettle the housing market,” said NAHB Chairman Jerry Konter, a builder and developer from Savannah, Ga. “Policymakers must take proactive steps to fix supply chain issues that will reduce the cost of development, stem the rise in home prices and allow builders to increase production.”

“The housing market faces an inflection point as an unexpectedly quick rise in interest rates, rising home prices and escalating material costs have significantly decreased housing affordability conditions, particularly in the crucial entry-level market,” said NAHB Chief Economist Robert Dietz.

emphasis added

This graph shows the NAHB index since Jan 1985. This was at the consensus forecast, and still a solid reading.

It appears homebuilders are still positive (Any number above 50 indicates that more builders view sales conditions as good than poor), but are concerned about mortgage rates and declining traffic.

There is significant uncertainty surrounding the housing market right now. How high will rates rise? How quickly will inventory increase? What will be the impact on housing starts, new home sales and house prices? We live in interesting times.