October existing home sales: a pause, or possibly reversal, in the rebalancing trend

 

 - by New Deal democrat

Yesterday’s report on existing home sales indicated, at least for one month, a pause or even reversal in the previous trend of abating price increases and increased inventory. While existing home sales are  not nearly so important to the economy as new home sales, to the extent that home buyers must pay more of their savings, and increased monthly mortgage payments, the less they have to spend on other consumer goods and services. So this pause or reversal is not good, although it may just be one month’s noise.

Existing home sales have been flat in the range of 3.85 -4.10 million annualized for almost two years. October’s report released yesterday indicated that continued, as sales were at 3.96 million units annualized:

But the moderation in the YoY% change in prices from the past few months reversed somewhat as the median price for an existing home increased 4.0% YoY (below graph shows non-seasonally adjusted data):

On a YoY basis, in response to the longer term decline in inventory, existing home prices have risen consistently since 2014, and accelerated during the COVID shutdowns. After briefly turning negative YoY in early 2023, troughing at -3.0% in May, comparisons accelerated almost relentlessly to a YoY peak of 5.8% in May of this year. 

Here are the YoY% comparisons since then:

June. 4.1% 

July.  4.2% 

August. 3.1%

September  2.9% 

October 4.0%

As I wrote above, YoY prices had been moderating. I suspect this month’s number was noise.

Finally the sharp rise in the inventory of existing homes abated somewhat last month. In August it was 22.7% higher YoY; in September 23.0% higher, but in October it declined to 19.1% higher YoY (below graph shows absolute numbers, not seasonally adjusted):

Last month II concluded my review of both new and existing home sales by saying:

”[T]hose trends [lower mortgage rates help in the sales of new homes, which has helped drive down demand somewhat for existing homes, which in turn has led to an abatement in their price increases and an increase in inventory] all continued as to the existing home market. Demand has been driven even further down, despite somewhat lower mortgage rates. This again led to more inventory and a continued abatement in price growth. I expect these trends to continue for awhile.”

Not so much this month. While sales remained in range, price appreciation increased and the pace of inventory accumulation decreased. Again, this may have just been noise in one month’s report, and/or it may be a reflection of the recent increase in mortgage rates back to 7.0%. Because the underlying fundamentals are the existing homes, including both prices and mortgage rates, are historically expensive, I expect the trend of the past few months to re-assert itself.

Initial claims are positive, while hurricane-adjusted continued claims are neutral

 

 - by New Deal democrat

This week’s jobless claims reflect a little more complex scenario than usual, because the hurricane effects have disappeared from initial claims and their four week average, but likely are affecting continued claims, and are also likely to have a negative impact for the unemployment rate in the next jobs report.

To the numbers: initial claims declined -6,000 to 213,000, the lowest since April. The four week moving average declined -3,750 to 217,750, the lowest since the beginning of May. With the typical one week lag, continuing claims rose 36,000 to 1.908 million, the highest since November 2021:

As is usual, the YoY% numbers are more important for forecasting purposes, and there initial claims were unchanged, while the four week moving average was down -2.3%. Continuing claims were higher by 6.3%:

Ordinarily the YoY% increase in continuing claims would be somewhat concerning. But let’s take a look at the NSA numbers for North Carolina (blue, left scale) and the the rest of the US (red, right scale):

Pretty obvious what is happening, no?

It becomes more obvious when we calculate the YoY% change in continuing claims ex-North Carolina:

They are up only 3.3%, in line with their readings for the past 7 months.

In short, once we account for the hurricane effects on continued claims, the result including initial claims is net positive.

Finally, let’s do the usual update on the forecast for the unemployment rate, looking at the YoY% changes:

Jobless claims suggest that the unemployment rate should be less than 10% higher than it was a year ago. This is a “percent of a percent,” which ordinarily would mean that since last November the unemployment rate was 3.7%, next month we should expect a number no higher than 4.1%.

I don’t think that analysis will work when the November jobs report comes out. Not only will we still have the effects of immigration have been putting upward pressure on this number, but so will the continuing unemployment caused by the hurricanes, as we have seen from the analysis of continuing claims above. In short, be prepared for a negative surprise as to the unemployment rate in the next jobs report.

What to look for if housing construction does forecast a recession

 

 - by New Deal democrat

No data today, but since it is mainly a housing week, let me pick up on a topic I discussed at the end of yesterday’s post; namely, if housing does indeed forecast an oncoming recession, what should we expect next in that sector?

To cut to the chase, ultimately we need to look to construction employment.

Briefly for background, I won’t bother reposting the graphs, but the most leading aspect of housing data are mortgage interest rates. After that the most leading data are new home sales (which are very noisy) and permits, with single family permits being the least noisy. Permits, starts, and sales all lead prices.

And, reposting from yesterday, permits substantially lead housing units under construction:

Permits also lead residential construction spending adjusted for headline inflation:

Now let’s compare housing units under construction with inflation adjusted residential construction spending. In the graph below I measure each YoY, and in the case of construction spending, subtract YoY headline inflation so that what is shown is the % by which YoY residential construction spending exceeds or trails overall inflation. Finally, I also include the YoY% change in employment in residential construction:

Inflation adjusted residential construction spending has typically led housing units under construction, and both have led residential construction employment.

For completeness’ sake, let’s compare house prices as measured by the Case Shiller repeat sales index with adjusted residential construction spending:

Construction spending has typically led house prices in the past 20 years.

In fact house prices adjusted for inflation have even lagged residential construction employment, and did not even turn down in the 2001 recession:

Now let’s bring the rest of the goods producing sector (mainly manufacturing but also notably non-residential construction employment) into the mix.

As we already know, manufacturing as measured by the ISM index has been contracting since 2022:

Again, although I won’t repost the graph, because manufacturing is only about 1/4 of the US economy, for recession forecasting purposes I have begun economically weighting it with the ISM services index.

So in the following graphs I compare the YoY changes in employment in residential construction, construction generally, manufacturing, and the entirety of goods production employment. 

First, here is the historical record from 1950 through 2002 (note that the subcategory of residential construction employment was only added in 1988):

Next, here is the period from 2003 until just before the pandemic:

Now here is our post-pandemic period:

Here’s the upshot of these three graphs: Focusing on manufacturing or residential construction employment alone is not enough. If one turns negative but not the other (e.g., 1966, 1984, 1994, 2002) a recession typically does *not* happen. It is only when there is a more broad-based downturn across multiple goods-producing sectors that a recession typically occurs. 

As you can see from the final graph, that YoY downturn has already manifested in manufacturing. It has not manifested in either residential or non-residential construction, nor in goods production generally.

Indeed, on an absolute basis, but residential and total construction employment are still increasing:

And total goods-producing employment only turned down in the past month (and that may be reflective of hurricane impacts):

To sum up: with permits, starts, and housing units under construction all down from their peaks, at levels at least close to consistent with an oncoming recession, the big item to look for is employment in residential construction, and construction generally. If manufacturing employment remains negative, and construction employment turns down, that would strongly indicate that more likely than not a recession is approaching.

Leading housing construction data stabilizes, while units under construction continue free-fall. With a continued hurricane asterisk

 

 - by New Deal democrat

Housing data for October, like that for September, has to be viewed with an asterisk, due to Hurricanes Helene and Milton. Since the effects of both were in the South Census Region, where relevant in the analysis below I will also discuss the numbers excluding that region.

The most leading metric, after revisions housing permits (gold in the graph below), declined -9,000 to 1.416 million. Excluding the South Census Region, permits increased 5,000. Single family permits (red), which are just as leading and have very little noise, rose 5,000 to 968,000, with revisions the highest since April. Excluding the South, they would have been unchanged. Housing starts (blue), which tend to lag permits by a month or two, and are much more noisy, declined -42,000 to 1.311 million. Excluding the South, they *rose* 20,000:

Accounting for the regional issues, this is a slight rebound from lows earlier this year, and it is what I have been expecting, for the simple reason that for 60+ years, mortgage rates have always led housing permits, and over the summer mortgage rates declined:

Given the upturn in mortgage rates in the past two months, this mild upturn is likely to be short-lived - although I am not expecting any new lows.

The bad news is that units under construction, the measure of real economic activity in this sector, declined another -29,000 (-19,000 excluding the South), or another 1.7% from its October 2022 peak, and is now down -14.4% from that peak. 

This is very important, because in the past it has declined on average -15.1% and by a median of 13.4% before the onset of recessions:

Two months ago I hoisted a yellow flag “recession watch” for the construction sector, based on this metric being down more than -10%. As of last month, and certainly continuing this month, it is at the level consistent on average in the past with the onset of a recession. The only reason I am not hoisting a red flag now is that, excluding the South, units under construction are only down -12.4%:

There are several other silver linings which suggest that we should not put too much weight on this decline.  The first is that in the lead-up to past recessions, the downturn was led by single family units under construction, the number of which continued to decline into recessions. This year the number of single family units under construction has remained stable for the past four months (far right of graph below):

Additionally, as shown in the long historical view of housing permits, with the exception of the tech producer-centered recession of 2001, they continued to decline sharply into the recession, and typically well after recessions had begun:

In our present situation, since it appears permits have bottomed, then housing units under construction will not decline too much further before bottoming as well. 

For those reasons, at this point there is only a housing sector ‘recession watch,’ meaning a heightened possibility, and not a ‘warning,’ meaning one is more likely than not. Once the hurricanes-induced asterisks are resolved, the issue will become whether mortgage rates continue to head back higher - in which case recession risks increase - or are at the top of their range going forward.

Whither housing? A look at interest rate and inflationary considerations

 

 - by New Deal democrat

Starting tomorrow we get to the time of month when the data on the important long leading sector of housing begins to be reported. So let me update a few important points about where this sector is likely going and its effects on the economy.

As we probably all know by now, housing costs in the form of Owners’ Equivalent Rent and Rent of Primary Rresidence are about 1/3rd of the entire CPI, and about 40% of core inflation. Where are they going?

Let’s start with rents. The Philadelphia Fed has an experimental “New Tenant Rents Index” and “All Tenants Regressed Rents Index” that are culled from the same data that gives rise to the CPI numbers, and are designed to lead the Rents portion of that index.

They were recently reported for Q3, and while unfortunately they are not presented in graph form, Ben Casselman of The Economist has provided such an update:

The graph suggests that the CPI measure of rents lags the “All Tenants” index by 2 quarters on average. Past day, most notably from 2009-10 and 2020-21 suggests that CPI for rent will continue to decelerate to approximately the same level as the All Tenants index, unless the New Tenants index rises significantly in the meantime. In Q3 the All Tenants YoY% increase was 3.8%, and the New Tenants YoY increase was 1.0%. On average the CPI rents YoY% change in Q3 was 4.9%. *If* the New Tenants index remains somnolent, this suggests the YoY% change in CPI for rents should decline to under 4% YoY in the next 4-6 months. In the past 6 months, the CPI for rent has risen at a 4.4% rate, so some further deceleration must occur if this forecast is to come true.

Similarly, the continuing slow decline in the house price indexes (FHFA is shown below) suggests that the CPI for Owners Equivalent Rent should also continue to decelerate:

There’s no magic 1:1 monthly correspondence to the lag in CPI vs. house prices. Above I show both the quarterly (dark red through Q2) and monthly (light red through August) changes in the FHFA index. Over the last two quarters, the YoY increase in the FHFA index has averaged roughly 5.5%. This suggests that the OER is currently “aiming” for roughly a 2.2% YoY increase in the next 12-18 months, depending upon the course of house prices in the near future.

But if shelter inflation can be expected to continue to moderate, the news is not so good about new construction.

As I always say, mortgage rates lead new construction. Here’s the latest updated graph of rates (blue, left scale) vs. permits (red, right scale):

More or less mirror images, with a slight lag between rates and permits. TNiehter the summer decline in rates, nor the subsequent increase, have yet been reflected in permits. Generally this suggests that permits will stay in the same range as they are presently.

Let me elaborate on this a little bit, and make a long term statement as well.

On the left below is a snapshot of the Treasury yield curve, showing its steep inversion in summer just before the Fed made its first rate cut (light red), and its current generally flat status (dark red):

As with the graph of mortgage rates above, what is most interesting here is that longer rates beginning at about the 7 year maturity have risen even as the Fed has cut rates twice. This suggests that the bond market, at the moment, thinks this will lead to a little more inflation. If mortgage rates do not meaningfully decline in the near future, the housing market is going to remain moribund.

And here is where the longer term secular issue comes in. It seems very likely that the next Administration is likely to want to pursue a high-deficit, easy money policy. If so, it almost certainly will ultimately get its wish with both the Congress and the Fed (after new appointments and possibly firings as well).

Such a policy is going to be inflationary, and is likely going to mean that long term interest rates like for mortgages will not return anywhere close to their post-pandemic lows.

Interest rates move in very long cycles. There was a declining rate long-term secular trend that started in 1981 and almost certainly ended in 2021:

Both the increases in the Fed funds rate and long term Treasury rates definitively broke those long term trend lines in the three years since.

And if there is going to be inflationary fiscal policy, and accommodating monetary policy, there is every reason to believe that we have started a new secular era that will be much like the era from the 1950s through 1981, which featured both increasing Fed interest rates and increasing inflation:

It is hard to imagine housing making any kind of strong positive contribution to the economy with those headwinds, unless by some miracle middle and working class incomes increase faster than inflation on a sustained basis.