I can point to the exact moment in Jay Powell’s press conference when the market mood crumbled: “We probably, in the housing market, have to go through a correction to get back to that place.”
Up until that point, investors were able to hang onto the hope that the work of wrestling inflation back to a level the economy can sustain in the long run wouldn’t be too painful in the short run. We believed that the tough medicine wouldn’t actually taste bad.
It turns out that there’s actual pain ahead for the real estate market, the kind that leaves a bad taste in your mouth. Home prices have probably peaked. From here, mortgage rates will be a drag on affordability. Those who bought too much house in the COVID boom and are hoping to flip for a profit are probably out of luck.
But that doesn’t necessarily mean a nationwide housing crash is on the horizon. Builders still have opportunities. They just need to focus a little harder on affordability.
That means smaller starter homes. That’s all right. Price per square foot has soared 300% in the last forty years, moving ahead of ambient inflation by about 1 percentage point a year, and those houses are about 600 square feet bigger on average than they were a generation ago.
Rewind to the kinds of development projects we saw in the 1980s and builders, brokers and mortgage originators alike will stay as busy as they want, even if lending rates keep increasing. As long as they focus on affordability, inventory will find buyers . . . and that’s exactly what Powell wants.
He wants to realign supply and demand. Demand is obviously fierce. The goal here is to artificially depress demand on the high end to bring on additional supply priced for the typical family.
But let’s be clear: mortgage rates below 3% were a historical aberration and homebuyers who needed close to a zero-rate loan to make a bigger offer on a house won the equivalent of a liquidity lottery.
Go back to previous boom times like 1996-9 and today’s mortgage rates are normal, even a little more lenient than they need to be. They didn’t exactly kill the housing market, did they?
And the rates on 30-year fixed loans weren’t the factor that triggered the 2006-8 crash, either. The problem there was truly the rise of unorthodox loan structures that exploded the minute the Fed started tightening.
Those loans barely even factored into the recent boom. And until they reappear, I think we’ll be spared the severe dislocations we suffered back then. All Americans need to do is keep earning enough to afford the loans we currently have.
The Fed is looking for about 1.3 million jobs to vanish from the economy next year. That’s going to hurt, but it’s only going to wind unemployment back to 4.4%, where it was for most of 2017.
Did 2017 feel like a deep freeze to you? Remember, unemployment only briefly got below 4.5% in the ramp into the 2008 crash . . . and 4.4% was the status quo in 1998 and 1999.
That’s as bad as the Fed wants it to get. And in the short term, they’re still looking at a backlog of 11 million unfilled vacancies as a sign that the job market is running too hot.
If every one of those job listings evaporates unfilled, the only pain is on paper. The only material impact on workers is losing the ability to write your own ticket after you quit. People will have to put up with jobs they don’t like in order to keep paying the bills.
Participation in the labor force has stalled. When the pandemic is really behind us, I’m thinking a few million more people will come back to the job market . . . but then that’s the end of the slack in terms of worker supply.
Weigh all the factors and the Fed doesn’t see mass layoffs ahead. Companies that are still desperate for labor do not fire the people they fought so hard to sign up unless the enterprise itself needs to wind down in a hurry.
These are the same companies that survived the run up in interest rates before the pandemic and then made it through the COVID lockdowns. Unless their balance sheets are complete fakes or they all suffer a severe shock, they’re built to last.
They’ll slow down. They might even stall. The Fed is looking for what amounts to an economic stall through the remainder of this year.
But a stall is a long way from a crash. Minimal positive growth is a long way from a dramatic contraction. The first sign of a real contraction will tell the Fed they’ve gone too far. Guess what? They’ll pause or take a step back.
And as Powell went on to say, simply getting out from under the inflationary shadow will start feeling incredible. We’ll keep working as hard to pay the bills . . . nobody expects prices to decline . . . but life stops being such a desperate struggle to avoid getting left behind.
That’s what price stability means. Powell really believes that the biggest threat to long-term expansion is the “inflationary mindset” of needing to run faster just to stay in place.
If the mindset and the logic behind it go away, we’ll be able to recognize growth when we see it. Even a little recession might feel like a boom.
At least, that’s the logic. For now, Wall Street is terrified. Let stocks drop to bargain levels. We’re active buyers.