A big chill? US housing, inflation and the Fed

June 26, 2022

David Bailin

Chief Investment Officer and Head of Citi Global Wealth Investments

Steven Wieting

Chief Investment Strategist and Chief Economist

SUMMARY

The US housing market woes caused by higher interest rates and the impact this will have on economic activity may provide important signals to the Federal Reserve. While the US economy is far less “housing reliant” than it was at the peak of 2008, a drop in housing will nonetheless constrain overall economic growth.

After a housing boom during COVID, the Fed’s focus on raising interest rates to “fight inflation” is having a direct, negative impact on housing and adjacent economic activity in the US. These areas represent a meaningful 16.7% of GDP.
Housing provides excellent forward visibility on a critical segment of the economy. When people buy more property, they also buy goods and services associated with their homes. And the opposite is true as well.
With shelter prices comprising about one-third of the headline CPI, the trajectory of the housing market will be a determining factor in the Fed’s ability to achieve price stability.
Housing prices feed through to the CPI with about a one-year lag, which means last year’s 17.1% surge in national home prices will keep core inflation elevated throughout much of this year. Ironically, the rapid rise in rates is causing rents to rise as homebuyers are shut out of the market.
The housing market is being “chilled” as new and existing home sales and construction have fallen at a double-digit pace in 2022. As new purchase mortgage applications fall, existing and new homes sales will fall further. We therefore expect meaningful decreases in both house closings and contract signings ahead, as well as much lower refinancing activity.
The direct impact the Fed has on mortgage rates – where mortgage spreads relative to US Treasuries have jumped higher – is reinforcing the need for the Fed to be concerned with this data.