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Homes Have Gotten Cheaper by Running in Place
As the Fed started lifting interest rates aggressively in early 2022, pundits almost universally declared the end of the housing market. Taking the rather lazy approach of projecting what happened in 2008-2010 and just changing the year, utter disaster was forecast for home construction, home sales, and home prices. The more clever analyses mused about how the higher interest cost of a mortgage lowered the amount of home that can be bought by a given payment, and suggested that home buyers would naturally back up their bids by that much and sellers would be obliged to hit those bids.
The Case-Shiller Home Price futures, which are (thinly) traded on the CME,[1] went from pricing in additional upward movement in home prices to pricing in a collapse worse than the post-financial-crisis debacle. For example, the February 2024 futures dropped 22% between May and November 2022. Keep in mind that these futures track nominal prices, so at the worst levels the futures market was pricing in something like a 25% drop in real prices.
That was never going to happen, especially in a housing market that was much, much tighter than in 2007. In the summer of 2007 there were approximately 3.4 million existing homes on the market; in the summer of 2022 the figure was about 1.2 million. And, as it turns out, homeowners did not hit any bid that was shown, which would have been irrational in an inflationary environment. Nominal home prices are sticky on the downside anyway, because buyers don’t like to sell below other recent prices which serve as an ‘anchor’ for their expectations. All of which is to say that 2007 really was an amazing outlier in a lot of ways: price, activity, builder activity, financial buyer activity, mortgage structuring, and home inventory. The current situation is much different.
Naturally, we all know that now as we have noticed that home prices have not in fact collapsed. But they have declined in real terms, because the overall price level has advanced while home prices have been flat. Given the level of inflation, this has actually changed the level of home valuation fairly substantially in a short period of time and I thought it worth pointing out.
Consider the following chart (Source: BLS, ADP, National Association of Realtors, author’s calculations). It plots the Existing Home Sales Median Price divided by the Median Annual Wage. I’ve used the Atlanta Fed’s Median Wage figures and converted them to annual wages so that the series matches, for the most recent point, the median annual wage reported by ADP.) By doing this, we can see roughly how many years’ wages it would take to purchase the median home outright. Note that one of the series is seasonally-adjusted and one is not, which causes the scalloping effect you see. I could correct for this, but figure this is close enough to make the main point.
And the main point is that as home prices have stagnated and wages have been rising rapidly to keep pace with inflation, the cost of a home relative to the wages people are receiving has dropped pretty sharply.
Although this measure doesn’t tell the whole story, you can see how there was a reasonable concern that home prices may have been getting ahead of themselves somewhat (although with extremely low inventory, that’s not necessarily unsustainable in the medium-term). However, since last summer homes have gotten much cheaper, by just staying in one place.
Don’t get locked in on the nominal price. That’s called money illusion, and in an inflationary environment it leads to mistakes.
[1] In full disclosure, we use the housing futures for one of our strategies.
Summary of my Post-CPI Tweets
Below you can find a recap and extension of my post-CPI tweets. You can follow me @inflation_guy or sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments.
- core CPI +0.157%, so it just barely rounded to +0.2%. Still an upside surprise. Y/Y rose to 1.69%, rounding to 1.7%.
- y/y headline now +0.0%. It will probably still dip back negative until the gasoline crash is done, but this messes up the “deflation meme”
- (Although the deflation meme was always a crock since core is 1.7% and rising, and median is higher).
- Core ex-housing +0.78%. Still weak.
- Core services +2.5%. Core goods -0.5%, which is actually a mild acceleration. So the rise in core actually came from the goods side.
- Accelerating major cats: Apparel, Transp. Decel: Food/Bev, Housing, Med care, Recreation, Other. Unch: Educ/Comm. But lots of asterisks.
- Shelter component of housing rose back to 3% (2.98%) y/y; was just fuels & utilities dragging down housing.
- Primary rents: +3.54% y/y, a new high. Owners’ Equiv Rent: 2.69%, just off the highs.
- In Medical Care, Medicinal Drugs 4.13% from 4.16%, but pro services +1.47 from +1.71 and hospital services 3.28% from 4.08%.
- In Education and Communication: Education decelerated to 3.5% from 3.7%; Communication accel to -2.2% from -2.3%.
- 10y breakevens +3bps. Funny how mild surprises (Fed, CPI) just run roughshod over the shorts who are convinced deflation is destiny.
- No big $ reaction. FX guys can’t decide if CPI bullish (Fed maybe changes mind and goes hawkish!) or bearish (inflation hurts curncy).
- Here’s my take: Fed isn’t going to be hawkish. Maybe ever. So this should be a negative for the USD.
This CPI report was a smidge strong, but just a smidge. The market was looking for something around 0.12% or so on core, and instead got 0.16%. To be sure, this is another report that shows no sign of primary deflation, but still it amazes me that inflation breakevens can have such a significant reaction to what was actually just a mild surprise. That reaction tells you how pervasive the “deflation meme” has become – the notion that the economies of the world are headed towards a deflationary debt spiral. I am not saying that cannot happen, but I am saying that it will not happen unless somehow the central banks of the world decide to stop flushing money into the system. And honestly, I see no sign whatsoever that that is about to happen.
As I wrote last week, it should be no surprise that this is a dovish Fed that will perpetually look for reasons to not tighten, and will do so only when the market demands it. My guess is that will happen once inflation, breakevens, and rates rise, and stocks fall. And this doesn’t look imminent.
Outside of housing, core inflation still looks soft. But housing inflation is accelerating further, as has been our core view for some time. The chart below (data source: Bloomberg) shows the y/y change in primary rents is at 3.54%. The median in primary rents for the period for 1995-2008 (the 13 years leading up to the crisis) was 3.20%. And during that time, core inflation ex-housing was 1.72% (median).
Like most data, you can use this to argue two diametrically-opposed positions. You might argue that the Fed’s loose money policy has helped re-kindle a bubble in housing, as inflation in rents of 3.54% with other core prices rising at 0.78% suggests that housing is in a world of its own. Therefore, the Fed ought to be removing stimulus, and tightening policy, to address the bubble in housing (and the one in equities) and to keep that bubble from bleeding into other markets and pushing general prices higher. But the flip side of the argument is that core inflation outside of housing is only 0.78%, so therefore if the FOMC starts removing liquidity then we may have primary deflation, ex housing. Accordingly, damn the torpedoes and full steam ahead on easing.
The data itself can be used right now to make either argument. Which one do you think the Fed will make?
Follow-up question: given that the Fed has historically one of the worst forecasting records imaginable, which argument do you think is actually closer to correct?
