Falling housing investment risks triggering a recession
Estimated second-quarter gross domestic product (GDP) data released Thursday shows the US economy is on the brink of recession, with an overall inflation-adjusted GDP decline of 0.2%. And if we do get a full-scale recession, it will be tied to sharp declines in housing and residential investment, which fell 14% in the quarter.
The Fed’s rapid series of interest rate hikes has been the most aggressive in nearly three decades and it’s hitting housing particularly hard, driving up mortgage rates and disqualifying many potential buyers. Rates on 30-year mortgages rose from 3.22% in early January to 5.3% in late July, adding hundreds of dollars to homebuyers’ monthly payments.
Builders notice the drop in the number of qualified buyers and stop building in turn. Rising interest rates also directly hurt builders, as they increase borrowing costs for construction.
The National Association of Home Builders reports that the confidence of single-family home builders has fallen to its lowest level in two years, recording the “biggest one-month drop” ever in their confidence index, at the exception of the start of the COVID-19 pandemic. This lack of builder confidence is reflected in lower building permits for new single-family homes, which fell 8% in June to their lowest level in two years.
The result? Residential fixed investment (RFI) fell in the second quarter by 14%, a very large drop and about a quarter of the total drop in private gross domestic fixed investment. (Investment in multi-family and prefabricated housing, which is part of RFI, also fell.)
This may sound like bad news to many of us, but that’s what the Federal Reserve wants: to cause a sharp economic slowdown and possibly a recession in order to control headline inflation. Many economists oppose the Fed’s actions, saying a recession is more harmful than current levels of inflation, especially since inflation does not appear to be driven by wages.
We may not get a full-fledged recession. Economist Robin Brooks of the Institute of International Finance tweeted that “the United States is NOT in a recession”. He said housing is in “collapse”, but private consumption growth is on the pre-COVID-19 trend.
Claudia Sahm, economist cites research showing that although low-income families suffer from inflation, job losses hurt them more, the damaging effects of higher unemployment lasting “for years.” And job losses are felt most strongly among “men, black and Hispanic workers, youth, and low-educated workers,” with ripple effects on low-income children.
Forbes contributor Teresa Ghilarducci recently asked, “Why is the Federal Reserve going to war on workers? She argued that the Fed is using “old and outdated thinking” based on the oil shocks of the 1970s and 1980s, but notes research linking our current inflation to pandemic-induced supply chain issues and oil prices. energy driven by Russia’s unwarranted invasion of Ukraine. None of these factors will be reversed by a rise in unemployment.
But the Fed fights inflation with the blunt instrument of higher interest rates. And as the old saying goes, “when you only have a hammer, everything looks like a nail”. So the Fed is hammering with the only tool it has.
The sharp decline in residential investment in today’s GDP figures shows the impact of rate hikes, with the decline in investment likely to continue as fewer buyers and more construction loans expensive reduce the construction of new homes. Ironically, this will mean less housing in the long run, and this lack of supply will help maintain upward pressure on rents and housing prices, supporting inflation. The Fed may therefore not get what it wants in terms of inflation, although its rate hikes will continue to depress housing construction.