With Inflation Now a Global Issue, a Soft Landing May be Challenging

The Federal Reserve plans to prevent recession by decreasing purchase of Treasury and mortgage bonds while hiking Federal Funds rate

By Patrick Duffy

Whether it is the cost of energy, building supplies, food or shelter, the high rates of inflation we’re continuing to see in the U.S. are now a global phenomenon, leading to unrest abroad and constant finger-pointing here at home. However, while the 8.5-percent rise in the Consumer Price Index year-on-year in March was the steepest in 41 years, for the same time period it was up 7.5 percent in the euro area and 7.0 percent in Great Britain. Indeed, across most developed and emerging economies, inflation is well above the targets of their respective central banks. So what does that mean for America’s economy and housing market?

The Federal Reserve is belatedly beginning to admit that it failed to recognize that higher inflation may be more stubborn than initially thought. The reasons for this myopia range from a too-insular and bureaucratic culture to a long-held assumption that higher inflation in a globalized world was a thing of the past. Now, hoping to prevent a recession with a ‘soft landing,’ it plans to gradually decrease its purchase of Treasury and mortgage bonds while hiking its own Federal Funds rate several more times this year.

Its updated March projections are now forecasting a median increase in the inflation-tracking PCE Price Index of 4.3 percent per year by the end of 2022, falling further to 2.7 percent in 2023 and 2.3 percent in 2024 as pent-up demand wanes and supply chains catch up. GDP growth for 2022, which was projected to grow by a median of 4.0 percent in December, has been downgraded to 2.8 percent before falling gradually to 2.0 percent by 2024. Meanwhile, the Economic and Strategic Research Group (ESR) at Fannie Mae is suggesting a modest recession in the second half of 2023 due to higher interest rates, but nothing that will come close to the downturn of 2008.

Although the labor market continues to improve with low unemployment levels and strong job growth, historic levels of churn have added additional complexity for the nation’s employers, as they have to prevent nearly 40 percent of their workers quitting for every new position they successfully fill. Those new hires, in turn, are demanding more competitive wages, better benefit packages and remote work flexibility, which for employers can mean lower profit margins, passing along these higher costs to customers, or some combination of both.

For the housing market, 30-year fixed mortgage rates that are up 70 basis points from mid-March through mid-April and 200 basis points year-on-year are starting to break the housing market fever in some markets, giving would-be buyers some additional – although more expensive to finance – breathing room. However, given that just over half of existing homeowners with mortgages have rates below four percent, many of them will prefer to stay put versus the unknowns of a move to somewhere different at a higher cost of borrowing.

“Given the higher energy efficiencies, smart home and green home advantages of newer homes, this shrinking new home premium thus presents a considerable potential advantage for home builders.”

Indeed, according to the NAR, March sales of existing homes fell for the second consecutive month, marking declines of 2.7 percent from February and 4.5 percent year-on-year. In turn, while that slowing demand did not yet impact sales prices – which were up 15.0 percent year-on-year – it did help add to existing home inventory, which rose nearly 12 percent from February and yielded a timeline of 2.0 months at current sales rates. Sales of new homes also began falling in February, declining 2.0 percent from January and 6.2 percent year-on-year, allowing inventory to rebound to over 400,000 units, or an inventory timeline of 6.3 months.

Notably, the gap between the median sales prices of newly built versus existing single-family homes was just 4.9 percent in February, or a fraction of the gap noted in previous decades. Given the higher energy efficiencies, smart home and green home advantages of newer homes, this shrinking new home premium thus presents a considerable potential advantage for home builders.

While it’s certainly true that home builder confidence has been declining lately due to ongoing challenges in sourcing materials, labor and suitable land, if existing homeowners increasingly stay in their homes out of reluctance to give up low mortgage rates, the only remaining solution out of the housing shortage is simple: build, baby, build. That will remain true whether or not the Fed manages a soft landing for the economy.

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