Whither Housing?

Much has been made over the past months' of red-hot inflation readings, and how supply-chain bottlenecks, a dearth of semiconductors, and labor or energy shortages have put upward pressure on prices. But some 40% of the U.S. consumer price index is tied to housing components, which are a wholly different bag. 

As compiled by the Bureau of Labor Statistics, the index includes conventional rent as well as owners' equivalent rent, which is what homeowners would pay to live in the homes they own and is sensitive to changes in home prices. Those are stickier forms of inflation than many of the other components. 

Many goods could see less demand as consumers return to prepandemic levels of services spending, just as supply-chain bottlenecks ease. That should help ease pressure on supermarket items, new and used vehicles, and other components of the CPI. It's also unlikely that gas prices will jump yet another 50% over the coming year, even if there's good reason to expect them to continue to move higher from here.

Housing is a tougher element of the basket to imagine declining. As with so much in markets this year, much will depend on the Federal Reserve. Barron's Lisa Beilfuss explains:

For perspective on the Fed’s influence over the housing market since it launched its emergency bond-buying program two years ago, consider this point by Richard Farr, chief market strategist at Merion Capital Group. Some 762,000 new homes were sold at an average price of $453,700 in 2021, meaning that the Fed—looking just at its $40 billion-a-month in mortgage-backed securities purchases—bought the equivalent of the entire new-home market last year, plus an extra 36%.

How the central bank handles housing—set ablaze by the pandemic’s push of people to suburbs and exurbs chronically short on inventory as Fed intervention torpedoed mortgage rates—will determine whether the Fed can realistically and sufficiently cool inflation without throwing the U.S. economy into a recession and markets into deeper corrections.

The central bank is about to raise interest rates, which affect mortgage rates, and could begin selling its enormous holdings of mortgage-backed securities later this year. Both of those should be headwinds for the U.S. housing market.

On the other side of the ledger is a growing economy and tight labor market. Plus, record-low inventory of homes for sale and lots of investor money chasing available properties could keep it a seller's and landlord's market for some time.

The stakes are high for the Fed. "As housing goes, so goes the economy," Lisa writes. "The sector makes up nearly a fifth of GDP, and more people own their homes than have substantial stock market exposure, making the so-called wealth effect deeply connected to real estate."

Read the rest of her report here.