Economy Continues Struggle to Find Balance

Recent history creates a useful guide for economy and housing market

By Patrick Duffy

These days it’s hard to fault anyone for feeling anxious about the paths of the overall economy or the housing market, since both are showing signs of seizing up due to a combination of incomes not keeping up with inflation, jumping mortgage rates making home purchases less affordable and stubborn, continuing mismatches between supply and demand. So how did we get here, and how long will these challenges last? Recent history may provide a useful guide.

Back in 2020, when public space lockdowns forced most people to stay at home, the combination of technology, boredom and free money courtesy of the federal government prompted a huge increase in the demand for goods versus services. Whether it was exercise equipment, new furniture or remodeling supplies, the spikes in demand for goods meant higher prices and longer wait times for anything created in a factory.

At the same time, for many the abrupt shift to remote work helped their housing dollars go much further away from crowded cities and other markets along the coasts. Even with these changes, however, successive waves of COVID-19 infection, the wait for the roll-out of successful vaccines and most service-related businesses struggling to thrive helped to keep overall inflation at bay.

By the third quarter of 2021, as more Americans received vaccines and the rates of infection waned, the country reopened faster than expected, resulting in a sharp shift away from goods and back to services, especially those related to travel, eating out in restaurants and personal care. In the housing market, existing homeowners with rising equity took advantage of record-low mortgage rates and increasingly traded in smaller, high-density homes to larger, single-family options in suburbs, vacation hotspots and smaller cities. 

Although these changes stoked inflation, it remained mostly contained to sectors in which supply/demand imbalances were the widest. As the demand for gas, diesel and aviation fuel rebounded, that resulted in oil prices jumping to their highest level since 2014.

That happened when Russia invaded Ukraine in late February 2022 and Western powers slapped on sanctions that oil prices truly turned parabolic, jumping to levels not seen since 2008. Meanwhile, China’s insistence on controlling outbreaks by mostly locking down parts of their own economy has led to regular back-ups at not just their own factories, but also at ports around the world. Add to that a tight labor market which has over five million more jobs versus unemployed persons and a still-elevated quit rate of nearly 3%, and it’s not surprising to see how higher inflation has spread throughout the economy.  So what now?

The uncomfortably high inflation we’re seeing in the U.S. is now a global challenge, with richer countries experiencing average annual increases of 9.0%, and developing countries often suffering even more.  While it is true that the trillions of dollars in federal stimulus and extra dollars created by The Federal Reserve were ultimately inflationary, a study by the bank’s San Francisco branch concluded those actions accounted for just three percentage points, or about 30% of the total year-on-year increase.

That leaves the remaining 70% due to other factors including supply/demand imbalances, workers demanding higher wages to keep up with spiraling prices and, perhaps most importantly of all, consumer psychology.  Back in the early 1980s, consumer expectations of higher inflation were so entrenched that it took sharp jumps in interest rates and the worst recession since The Great Depression to contain it.  However, the recovery which followed paved the way for the lengthy expansions of the remainder of the 1980s and the 1990s.

Today, surveys of consumers by the University of Michigan do point to expected higher inflation rates over the next year, and long-term guesses of about 3.0% – a full point over the Federal Reserve’s own stated goal– suggests that Chair Jerome Powell has to engineer a soft landing for the economy while also rebuilding his institution’s trust with an anxious public. 

For the housing market to rebound, lower long-term mortgage rates will resume only after inflation has been tamed, but for now buyers can take advantage of various ARM products to lower the payment sting. For home builders at the moment, the build-to-rent market is still the best place to be.

Patrick Duffy is a Principal with MetroIntelligence and contributes to BuilderBytes. He can be reached at pduffy@metrointel.com or at 310-666-8288.

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