Fed plans to ‘reset’ the housing market — raising the possibility of falling house prices

It’s not just about that how expensive the house is—This is how quickly it got there. It’s just It took 24 months for U.S. house prices to rise by a staggering 37%. For comparison, the biggest two-year spike leading up to the 2008 home collapse was 29%.

Towards this spring, the Federal Reserve decided it had seen enough. The central bank was quick to raise interest rates, which was seen the average 30 -year fixed mortgage rate increased to 6%—From 3.2% at the start of the year. Those higher prices, which have cost many home buyers, finally ended the pandemic housing boom. Now we are in a sharp slowdown, with the Mortgage Bankers Association reporting on Wednesday that Mortgage applications decreased 16% on a year-on-year basis.

While this shift has taken place, we have heard very little from the Fed. Well, until then chair Jerome Powell spoke to reporters on Wednesday.

This is what Powell said: “We saw [home] prices have been rising very fast over the past two years. So that’s changing now. And rates have gone up. We know that lending fees have increased significantly. And you see the housing market changing. We’re looking at it to see what happens. How big of an impact does this have on residential investment? Not really sure. How big of an impact does this have on home prices? Not really sure. Apparently we watched that well… It’s a tight market. So prices may continue to rise for a while, even in a world where prices are rising. So it was a complicated situation and we watched it very carefully. I would say if you are a home buyer, a person or a young person looking to buy a home, you need a little reset. We need to go back to a place where supply and demand have returned and where inflation has declined again, and lending rates are low again. “

Three things come first.

1. Powell says home buyers “need a little a reset

In the housing industry, the total number of active listings is called “inventory.” Since 2014, the annual inventory level has been declining. That’s because of changing household preferences (i.e. staying taller), low levels of homebuilding after the 2008 housing crash, and the start of millennial first-time home buying. But when the pandemic housing boom began, inventory levels began to decline. In the spring of 2021, inventory hit a 40 -year low. That gives buyers little option other than bidding on home prices.

Powell was clearly hopeful the housing cooldown due to rising lending fees help push the inventory level up. Powell suggests that this can help buyers, the thinking is: If buyers start again in their search for a home, they will find themselves in a more friendly market. Higher inventory levels will give buyers more time to decide, and reduce the chance that they will engage in a bidding war.

Even before the Fed raised its fight against inflation, Logan Mohtashami, lead analyst at HousingWire, was apparently rooting for higher lending rates as a way to increase inventory levels. According to the National Association of Realtors, U.S. housing inventory rose to 1.03 million heading into May. But to return to a “normal” housing market, Mohtashami said, inventory would have to rise to 1.52 million to 1.93 million housing units. The nationwide inventory level (see chart below) has risen sharply, however, and more than half of the region’s housing markets still have inventory levels 50% below pre- pandemic.

Check out this interactive chart on Fortune.com

“We need balance… The housing market is still not healthy because America’s total inventory level is less than 1.52 million,” Mohtashami said.

2. Lowering home prices? Powell seems to have suggested that this is possible

Fed Chair Powell raised the hypothetical of lowering house prices on Wednesday: “How big of an impact will it have on housing prices? Not really sure. Apparently, we’re watching that very closely. You think over time … There is a huge amount of supply in the housing market of unfinished homes, and as it comes online … ”

He then pivoted, and said: “While the supply of finished houses, the inventory of finished houses sold is extremely low, historically low. Rates are already high. That is why it is a complicated situation and we take good care of it. “

For a moment Powell seems to say that house prices will fall. However, Powell did not rule out a fall in house prices. That is important. Historically, with the exception of the Great Depression and the aftermath of the housing collapse of the 2000s, annual decline in home prices has been virtually non -existent. But current conditions could take us to a unique time where home prices are actually falling. It said Powell did not close the door on the possibility of a reduction in home prices, and instead said that “we are watching that closely.”

Last month, Moody’s Analytics chief economist Mark Zandi said luck that rising lending rates are pushing us to a complete “housing correction.” In the foreseeable future, Zandi expects the house price to increase annually from 20.6% to 0%. In significantly “overvalued” housing markets, he expects a 5% to 10% reduction in home prices. If a recession comes, Moody’s Analytics says it expects a 5% drop in U.S. house prices and a 15% to 20% drop in more “excess value”. housing markets. (Moody’s Analytics identifies “overweight” by comparing house prices in the region to what local economic criteria such as household income can historically support).

Check out this interactive chart on Fortune.com

Why are home prices now likely to decline? It starts with the fact that house prices isolated from underlying economic fundamentals. Basic economic theory teaches that house price growth and income growth are interrelated, and one cannot run for long periods of time. That affordability crunch is only exacerbated by rising mortgage rates. In fact, in the last six months the average new loan payment has increased by 52%according to Zonda, a real estate analysis company.

Home prices could fall, though, but for that to happen inventory will likely have to rise even higher. If the U.S. inventory level rises above 2 million units, Mohtashami said, house prices could start to fall in the country on a year-on-year basis.

If the Fed’s “over-tightening” causes a recession, Ralph McLaughlin, chief economist at Kukun, a real estate data and analytics firm, says inventory could reach levels that allowing house prices to fall.

“It looks more likely that we’re approaching a sharp inflection point in the market,” McLaughlin said. luck.

3. Powell has clearly said he wants to see mortgage rates fall

The central bank raised interest rates to stop the pandemic housing boom and kidney in runaway inflation. Once the Fed has control of inflation, high mortgage rates may begin to recede.

Check out this interactive chart on Fortune.com

As such, home buyers who are excited for lending rate relief may have to wait a while. Since last week, the Consumer Price Index is at 8.6%. The Fed will not stop fighting inflation until the CPI returns to 2%. On Thursday, the Fed clarified that this fight could last until 2024.

Hungry for more housing data? Follow me on Twitter at @NewsLambert.

This story was originally featured in Fortune.com

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