Aberrations, surprises and odd builder behavior is the order of the day
If there were a theme song invoking the mercurial nature of the housing market in the past several months, it would have to be “What a Long Strange Trip It’s Been,” although it’s a safe bet the Grateful Dead weren’t singing about mortgages at the time.
That’s the impression one gets in talking to Douglas Duncan (pictured), senior vice president and chief economist at Fannie Mae, in trying to get a grasp on what’s going on. Hardly clear-cut, it’s a matter of unusual housing market dynamics; home price growth surprising to the upside; higher levels of new home sales despite what you may have read or heard.
It’s almost like what was up is now down, black is white, two plus two is five, dogs and cats living together. Amid the chaos and uncertainty, Mortgage Professional America reached out to Duncan for some insight. In an interview on Tuesday, he predicted what the Fed might do in the way of interest rates as the body convened during the first day of its two-day meeting.
Will the Fed increase the rate again?
“We don’t expect them to increase rates,” the Fannie Mae economist said during a telephone interview, throwing yet another curve ball to the mix. “We differ slightly from the consensus although it’s pretty close to 50-50 with folks on whether they think the Fed will increase one more time or not. We would agree the risks are toward tightening, but we don’t have it in our forecast.”
But – in keeping with the uncertainty of the times – it all depends: “We do not have another increase in our forecast but it really depends on whether growth in the fourth quarter slows from the third quarter,” Duncan explained. “If it does not slow for the third quarter then they’ll put another quarter point in there, I think. So that’s the bet at the moment. Our forecast has no more rate increases in this cycle.”
Which is not to say there won’t be a rate cut in the coming months. But – again in keeping with the unpredictability of the times – it will be in response to a “mild recession” Duncan sees across the horizon: “We have the first cut in rates in at the end of the first half next year because we think there will be a mild recession,” he said.
What is a mild recession?
So what exactly does he mean by a mild recession? “Unemployment runs up maybe pushing 5%, which 20 years ago they would’ve thought was not a recession but pretty close to full employment,” he said. “And growth dropping by maybe 0.5% across the course of the year. So pretty mild. Housing will actually do OK in that environment and is one of the reasons why it is mild in that timeframe.”
Another surreal sign of the times is the Fannie Mae Home Purchase Sentiment Index® (HPSI) remaining effectively unchanged in August, as consumer confidence toward housing continued along the low-level plateau set earlier this year. Three of the HPSI’s six components increased month over month, most notably the component measuring perceived home-selling conditions.
In August, 66% of consumers reported that it’s a good time to sell a home, compared to only 18% who said it was a good time to buy a home. Additionally, despite the significant rise in rates over the last couple of years, only 18% expect mortgage rates to go down in the next 12 months. Overall, the full index is up 4.9 points year over year. Such unusual housing market dynamics contribute to a general stall in consumer sentiment, Duncan suggested.
“The index tends to move slowly in different directions, but it rarely plateaus and right now it’s sort of plateaued at the same place for about five months,” Duncan said. “That’s unusual in the history of the index, which typically moves from month to month. It’s sort of a signal that people have resolved themselves to living with the current level of house prices and interest rates for a while.”
He pointed to even more aberrations to what we once knew. “There are two things in the market today, two measures, that are anomalies,” he said. “One is there’s a long term relationship between the share of homes sold which are new homes versus the share of home sold that are existing homes.
“Today, the share of total home sales that are new home sales is the highest it’s ever been. So the lock-in effect of low interest rates and the Boomers aging in place has meant it has pushed the business more toward new home sales and construction,” Duncan said. “Then within new home sales, the first-time homebuyers’ share of new home sales is the highest it’s ever been.”
Builders putting the cart before the horse
Builder behavior yields another oddity, as Duncan noted: “So one of the things that you’ve seen that is unusual is when builders are typically trying to work down inventory they all offer attributes of the house – a finished basement, granite countertops, classic things that will add some attribute upgrades to the house to sell the house. But, first-time home buyers are not looking for upgrades; they’re looking for a basic house and their problem is affording the house in the first place.
“So what you saw when mortgage rates hit 7% was builders started offering 2-1 buydowns of interest rates because the share of new home purchasers that were first-time home buyers with that affordability problem was the place they had to go to move inventory. So it’s a significant difference in the way the new home sales market has been working typically. You would not have seen builders making that kind of an offer. For first-time buyers, the biggest challenge is the down payment and affordability – both of those being an issue today.”
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