- by New Deal democrat
Twenty years ago, Professor Edward Leamer gave an important presentation at the Fed’s Jackson Hole meeting entitled “Housing IS the Business Cycle.” The current environment is putting that hypothesis to a very severe test. Because by all accounts housing has deteriorated sufficiently that a recession should already have begun months ago. In fact, the current situation would be most congruent with such a recession ending! And yet, here we are.
Let’s take a more detailed look.
As I often do, let me start with mortgage rates (blue, left scale) compared with single family permits (red, right scale). Typically housing permits and starts follow mortgage rates, and for most of the past several years they had been declining from their post pandemic high of over 7%. In February they made a new 3+ year low of 5.99% before the Iran war oil shock drove rates higher, to 6.67% earlier this week. The decline in rates before March had been sufficient to reverse the trend in single family permits (red, right scale), which began to rise from their bottom early last summer:
In April, housing starts (blue), which are noisier and slightly lag permits (gold), declined -42,000 to 1.465 annualized. Permits rose 79,000 to 1.442 million. But the metric which is the least noisy as well as being most leading, single family permits (red, right scale), declined -23,000 to 872,000 annualized:
On the one hand, the recent increase in mortgage rates may well be behind the decline in single family permits to their second worst level in three years. But what appears most noteworthy about the above data is that the downward momentum in the numbers has almost completely stalled since last June. Single family permits have varied between 867,000 and 929,000, while total permits have varied between 1.347 million and 1.540 million.
On a YOY% basis, starts are down -4.6%, while permits are down only -0.2% and single family permits are down -8.5%:
As I noted last month, the YoY downtrend has not been worsening for many months. Typically all three have been down 20% or more at the onset of recessions in the past, although in the 1991 and 2001 recessions, they were only down about -10%; and there have been a number of times, for example 1966, 1987, and 1995, where construction has been down -10% or more YoY without a recession occurring:
Further, negative but relatively minor and stable negative YoY changes have been just as consistent with mid-expansion slowdowns as with recessions, and stable if negative YoY changes have sometimes occurred during recessions a few months before recoveries.
Let’s turn next to the number of housing units under construction. As I have written many times in the past several years, it is the best “real” measure of the economic impact of housing. In March they were rose slightly to 1.275 million annualized, just above their five year lows, and down -25.6% from their peak:
The above graph shows how they have followed single family permits (red), as expected. More often than not in the past by the time a decline in units under construction had declined by this much, a recession had already begun.
Now let’s update the graph of the typical final shoes to drop before recessions, including houses for sale (gold) and residential construction employment (red, right scale), both normed to 100 as of their respective post-pandemic peaks. Since December, both of these have stabilized at down roughly -5% and -2% respectively, from their peaks:
As I concluded last month, this is a quandary. For nearly the past year, almost all of the indicators in the housing sector have been giving classic signs that a recession should already have been underway. And while a number of coincident indicators, including jobs and real personal income, have been consistent with a shallow recession since then, others - most notably real manufacturing sales and industrial production - have continued to increase.
But instead, as discussed above there are a number of signs that the situation has been bottoming, without a recession having occurred. While the renewed upturn in mortgage rates may, and likely will, cause at least some further downturn in housing permits and starts, at the moment Leamer’s thesis is facing a severe test, to say the least.