The Fed Faces A Housing Conundrum

Federal Reserve Chair Jerome Powell may have a problem on his hands. Buoyed by three interest-rate cuts, not only did the U.S. housing market stand as a pillar of economic support in 2019, it largely offset the protracted slowdown in business investment. Now, though, cracks have begun to appear in housing.

Focusing solely on forward-looking indicators of residential real estate, the direct input to gross domestic product, building permits in the South and Northeast, which account for about 60% of permits, fell in December. As for what’s to come on the sales side, pending homes sales fell by 4.9%, the steepest decline in a decade.

Neither of these data points place housing at risk. The 5.8% gain in residential real estate that supported fourth-quarter gross domestic product topped the third quarter read of 4.6% of GDP that followed a contraction in seven of the prior eight quarters. Even as consumption has faded, this strength should hold. December was one of the warmest for that month on record, and construction data released for that month indicates residential’s contribution to GDP was even higher than initially reported, which will lead to an upward GDP revision. December single-family housing starts, at 1.61 million on a seasonally adjusted annualized rate, were the most in 13 years.

Even with this strength, it’s hard to ignore the dip in housing permits and weakness in pending home sales, which were not aberrant in any way, as the softness was not isolated to any pocket of the country. Pending home sales fell 4.0% in the Northeast and 3.6% in the Midwest. And in the critical building hubs of the South and West, pending sales sunk 5.5% and 5.4%.

While many factors are no doubt at work, affordability is key. The downside to the Fed’s tightening campaign throughout 2017 and 2018 was also its silver lining. In March 2018, just as Powell was getting settled two months into office, gains in home prices as measured by the S&P CoreLogic Case-Shiller index topped out at 6.5% over the prior 12-month period.

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