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“Why Aren’t Home Prices Falling?”
From time to time, I like to point out errors that we make because we think in nominal space, or because we had 25 years of inflation being so low that we didn’t have to think about it very much. I do think that at some level, we should consider pointing the finger at economics education, which teaches static equilibria until you get into fairly advanced (graduate level) classes – and even then, generally in nominal terms.
There’s a very good videocast that I like to check in with occasionally, by Altos Research, which runs through recent data on home buying trends along with useful commentary. It tends to be more thoughtful and to not fall victim to the wild swings of emotion that seem to affect a lot of housing market observers. I think it’s important for me to say that I like this channel, since I’m about to criticize an episode they recently put out.
It was called ‘Why Aren’t Home Prices Falling?’ and you can find the quick 15-minute video here: https://www.youtube.com/watch?v=J-0bkqeFZEE. You can get a good feel for the videocast, and the useful analysis they bring, from this episode.
But the question ‘why aren’t home prices falling?’ is an odd one. Median CPI is still running at 4.2% y/y. Sticky CPI is +4.1%. Apartment rents are +5.0% and never declined y/y, even when there was a rent moratorium. Asset prices in general are quite a bit higher over the last few years also, so whether you’re looking at homes from the standpoint of an investment or a consumption item, it’s hard to see why one would naturally default to ‘home prices should be falling.’
The thought process is that ‘home prices went up so much, no one can afford them! Therefore, prices should fall.’ This thought process does not originate with Altos; they are just trying to answer the question being asked. In my view, though, they aren’t answering the right question. Really, when you think about it, the whole framing of the question evokes Yogi Berra saying that ‘no one goes to that club any more because it’s too crowded.’ Home prices going up a lot is a pretty serious piece of evidence that supply and demand has previously cleared at a price that (it is assumed) is too high for people to afford. That should sound odd.
The thought process goes further by noting that the volume of transactions has really declined markedly over the last couple of years, thanks to high interest rates keeping supply off the market as homeowners with current low interest rates locked in recognize that buying a new home would involve an effective refinancing to more expensive money. But if that restriction in supply is the main reason that home prices didn’t decline, then why have home prices in Australia and the UK also generally been rising, except for a dip around the same time that we had a dip in the US? Australian mortgages are normally floating-rate, and in the UK a 5-year fixed rate is the standard. But the low y/y change in Australia (according to the Dallas Fed’s index of Australian home prices – don’t ask me why they track Australian home prices) in 2023 was -4.3% (now +7.7%), the low in the UK was -2.5% (now +2.2%), and the low in the US was -3.4% (now +2.9%, using Existing Home Sales Median y/y). All of those markets saw very large rises, small and brief declines, and are now rising again.
These are very different property markets, very different mortgage markets, very different governments, taxation regimes, populations, and yet they have strikingly similar patterns of home price changes in a market that classically is all about ‘location, location, location.’ This should lead the thoughtful analyst to think that there’s something else going on.
The something else – not to beat a dead horse again – is the change in the quantity of money, which has followed a very similar pattern in every major economy in the years after 2019. And this is where conventional Economics education falls short. Here is a chart of the y/y changes in US M2, alongside the y/y change in Existing Home Median sales prices.
Not all of the price changes you are seeing in homes is a ‘real’ price change. Much of what you are seeing is a change not in the value of a home, but in the value of the currency unit relative to durable physical assets. But in Econ 101, they’d tell you that you should look at changes in supply and demand, and that will predict changes in the price and quantity at which the market clears. In that narrow frame, you might look at the large increase in home prices and attribute it to changes in demand due to declining interest rates, although you’d be confused when the massive increase in interest rates caused only a modest and temporary drop in nominal home prices. (In late 2022, the Case-Shiller futures for end-of-2023 were pricing in a 19% decline in nominal prices with inflation at a positive 3-5% per year, implying an unprecedented collapse in real prices).[1]
Obviously, that frame doesn’t make sense when the underlying price level is rapidly changing, and the underlying quantity of money is rapidly changing. This is often more obvious when we make it extreme. Suppose the money supply went up 400%, and prices quintupled as well, and interest rates went to 100%. Would you expect home prices to decline in nominal terms? That would be absurd – the price level going up by a factor of 5 means that the value of the measuring stick is what is changing. And remember, it is entirely consistent to have the volume of transactions decline sharply while the nominal price increases. Homebuilders care about the volume of transactions; homebuyers care about the price. You may be absolutely bearish on homebuilders, while still expecting home prices to increase, especially if the price level is increasing.
That’s exactly what we have been experiencing. And, with the money supply growing again and median prices still rising at 4% per year, it does not seem to me that there is any natural reason to expect home prices to decline. So the short answer to the question ‘Why Aren’t Home Prices Falling?’ is ‘There’s no reason they should.’
[1] Markets are where risk clears, not where investors ‘expect’ prices to be, and there were wonderful gains to be made even well into 2023 by helping the nervous real estate longs clear their risk. https://inflationguy.blog/2023/08/29/home-price-futures-curve-still-looks-weird/
Inflation Guy’s CPI Summary (August 2024)
Let me start with the punch line, which I think will not be a very common take: this report does not stop the Fed from easing 50bps next week, and honestly doesn’t really even hurt the chances very much.
The inflation swaps market was pricing in 0.05% on an NSA basis, roughly 0.13% on a SA basis. Actually, that market was better offered, with traders either expecting a weaker number or wanting to hedge that possibility more than the chance of a stronger number. Economists gathered around a consensus of 0.16% for headline, and 0.20% on core CPI. The actual print was +0.19% m/m on CPI, and +0.28% on core CPI, bringing the y/y numbers to 2.59% and 3.27% respectively. It was the worst monthly core print since April, and the initial market response was predictably poor.
My early estimate of Median CPI for the month is +0.26% m/m, bringing the y/y median to 4.16%. (Sharp-eyed readers will note that neither headline, nor core, nor median CPI are at the Fed’s target).
Interestingly…at least, if you’re the kind of square who finds the CPI interesting…the y/y changes in Core Goods (-1.9%) and Core Services (+4.9%) were steady. That’s the first time in a while we’ve seen that.
Wow, right? A rounded +0.3% on core CPI takes the Fed out or at least puts them on a 25bps cut, right? Well, not so fast. The monthly change in Owners Equivalent Rent immediately jumps out at you (at least, if you’re the kind of square who looks at these things deeply) as +0.495% m/m. That’s the largest m/m change since February, and it hasn’t been appreciably higher on a regular basis since early last year.
That looks a little quirky, especially following the recent dip. And it looks suspiciously like a one-month-lagged chart of the m/m changes in Primary rents, which dipped a few months ago before paying it back last month.
That looks to me like some weird seasonal wrinkle. The y/y shelter figures are still declining. But, if you look carefully, you can see that the rate of improvement is slowing. And maybe my math isn’t so good but it doesn’t look like these are converging on deflation.
The rents data are therefore both the good news and the bad news. The good news is that in this month’s CPI, it was a miss higher only because OER had the quirky jump. I’ll get into more of the number in just a second, after sharing the bad news: there is nothing in the trajectory of rents to suggest that the operating theory of many forecasters for a long time – that rents would soon be in deflation – is going to happen. Heck, as I keep pointing out the trajectory of rents is higher than my bottom-up rents model, which suggested we should be bottoming out around 2.4% y/y right about now. And my forecast was on the very high side of what people were saying.
But let’s get beyond rents. The ‘big sticky’ is always important to watch, but outside of rents things looked pretty good this month. There were some outliers on both sides (Lodging Away from Home +1.75% m/m, Airfares +3.9% m/m after 5 straight declines; Car/Truck Rental -1.5% and Used Cars -1% m/m), but core CPI ex-shelter declined to only +1.72% y/y. The list of monthly categories shows a long list of categories whose price fell m/m: jewelry, car/truck rental, used cars, energy services, miscellaneous personal goods, personal care products, household furnishings and operations, medical care commodities, medical care services, recreation, communication, and a few others. Not that we are headed for deflation, but look at this distribution of y/y price changes. I haven’t shown this for a few months.
Again, this doesn’t look like something that screams deflation, but the far right tails are all moving left. There’s still a cluster around 4-5%, which shouldn’t be surprising since Median CPI is at about 4.2%. Do also notice that there aren’t a lot of categories showing deflation on a y/y basis, but if you take out shelter from this you get something that looks more disinflationary: a mode around 4-5%, but tails to the downside. In inflationary periods, the tails stretch to the upside, and we had that for a while; but the signature of the overall distribution is encouraging.
The conclusion, as I said up top, is that if the Fed was leaning towards cutting rates 50bps next week this is not a number that should change their collective mind very much. Unless the Fed cares only about the top line numbers, this isn’t an alarming report. It isn’t the lovely deflationary print that bond bulls wanted, but that wasn’t really in the cards. We’re arguing over a couple of hundredths in the monthly core print, and that is entirely attributable – still – to shelter. In fact, there are signs of broadening disinflation. To be clear, I personally do not think the FOMC should stop quantitative tightening and there’s no hurry to cut rates. The fight against inflation is not only unfinished, it won’t be finished for quite a while…and an ease now will just make it harder later. But that’s what I would do. What I am saying is that the Fed is not likely to change course on the basis of this number.
The y/y figures for headline CPI are going to keep dropping for a few months here, partly on base effects and partly because energy prices are very weak. A perfectly reasonable trajectory for monetary policy (if you think that rates ought to at least be eased back to neutral in the 3-4% range) would be 25bps next week, and then larger cuts in a few months when the headline inflation number is lower and the unemployment rate is higher. The only problem with that approach is that an acceleration in the pace of easing later may look like concern, which is why some FOMC members favor getting out of the gate quickly. As I said, there’s nothing here that should stop that.
But median inflation is still headed for ‘high 3s, low 4s,’ with a potential dip into the low 3s before a reacceleration. The hard work on inflation is still ahead, and it is going to get harder now that we are in a recession.
