The Fed will restore the housing market through a “difficult correction”: 5 things to know about the plan

“I would say that if you are a home buyer, someone or a young person looking to buy a house, you need some Reset. We have to go back to a point where supply and demand are back together and where inflation is low again and mortgage rates are low again, ”Powell told reporters at the time.

In the months that followed, economists openly questioned what Powell meant by “housing restoration”. Does the Fed simply want buyers to pull out long enough to allow inventory to rise? Or does “reset” mean that the Fed also wants house prices, which have risen 43% in just over two years, to fall?

On Thursday, CNN business reporter Nicole Goodkind asked Powell to clarify what “housing restoration” means. Here’s his long-winded answer.

“When I say reset, I’m not looking at a particular specific set of data. What I’m actually saying is that we’ve had a blistering real estate market period across the country, where homes were notoriously being sold to the first buyer at 10% more than demand even before we saw the house. That kind of thing. So there was a great imbalance between supply and demand. The houses were rising to an unsustainable level fast. So the deceleration in house prices we’re seeing should help bring prices more in line with rents and other real estate market fundamentals. This is a good thing. In the long run, what we need is for supply and demand to better align so that house prices rise at a reasonable level and pace and that people can afford houses again. We will probably have to undergo a correction in the housing market to get back to that point. There are also long-term problems with the housing market. As you know, it is difficult to find lots now close enough to cities, so builders have a hard time finding zoning and lots, workers, materials and things like that. But from the point of view of the business cycle, this is difficult [housing] the correction should bring the housing market back into better balance, ”Powell told reporters Wednesday.

While Powell has not provided a simple answer, he has given us clues as to where the Fed’s real estate “reset” will lead to the US housing market.

1. We are in a “difficult” [housing] correction”

Not long after the Federal Reserve began exerting upward pressure on interest rates this spring, the housing market went into cooling mode. While the slowdown began mildly, it has since intensified. Year-on-year, new home sales and existing home sales are now down 29.6% and 19.9%.

That sharp real estate slowdown is not a normalized market, it’s a real estate correction. At least that’s according to Powell.

“In the long run, what we need is for supply and demand to better align so that house prices rise at a reasonable level and pace and that people can afford houses again. We will probably have to undergo a correction in the housing market to get back to that place, “Powell said Wednesday.” This is difficult. [housing] correction should bring the real estate market back into a better balance ”.

This housing correction, of course, has already begun. In May, Mark Zandi, chief economist at Moody’s Analytics, said Fortune that rising mortgage rates coupled with frothy house prices would push the US housing market into a housing correction. A housing correction is a time when the housing market, which has been priced at 3% mortgage rates, would have worked towards equilibrium. As homebuyers retreat, Zandi says the housing correction will see inventory levels rise and home sales volumes decrease. Moreover, he said, it would put much of the nation at risk of falling house prices.

2. The real estate “correction” exerts downward pressure on house prices.

Although Powell hasn’t come out to say this, many real estate analysts believe the Fed’s real estate “reset” is a code for falling home prices. A vision also shared by Fortune.

“Clearly the change in the Fed’s choice of words from ‘housing needs a reset’ in June to ‘housing repair today actually means a correction’ indicates that they are doing quite well with falling home prices, sales. of homes cooling down and construction shrinking significantly to achieve their mission, “says Rick Palacios Jr., head of research at John Burns Real Estate Consulting Fortune.

We have already seen real estate markets in the West slide towards house price corrections. According to Zillow, 117 regional real estate markets experienced a decline in home value between May 2022 and August 2022. This includes high-cost technology hubs like San Jose (down 10.6%) and San Francisco (down 7%). 8%). It also includes sparkling markets like Austin (down 7.4%), Boise (down 5.3%), Denver (down 4.3%), Las Vegas (down 2.3%) and Phoenix (down 4.4%).

The reason we are vulnerable to falling house prices is quite simple. The pandemic housing boom has seen house prices across the country soar far above what incomes would have historically supported. In some markets, such as Phoenix and Las Vegas, it mirrors levels reached during the 2000s housing bubble. On Wednesday, Powell told reporters that the housing correction could help balance those fundamentals.

“The longer it is [mortgage] the rates remain high, our opinion is that the accommodations will continue to feel it and have this mode of restoration. And the accessibility restoration mechanism at this moment that needs to happen is active [home] prices. And so there are many markets across the country where we expect house prices to drop by double digits, “says Palacios. Fortune.

3. The “fix” of the accommodation broke the fever. This should restore balance.

This summer, Federal Reserve researchers released a paper discovering that the pandemic housing boom was driven by increased demand, not supply constraints.

“Even though the supply of new listings for sale dropped dramatically at the start of the pandemic, we show that the reduction in supply was a minor factor than the increase in demand to explain the tightening of housing markets in the first year of the year. pandemic, “the Fed researchers wrote.” Our estimates imply that new construction would have had to increase by about 300% to absorb the increased demand of the pandemic era. ”

The ongoing housing correction has halted that boom in demand. Once mortgage rates moved north of 5%, home buyers began to guess the moves to markets like Austin and Boise. Other buyer groups that helped drive the pandemic housing boom, such as fins and second home buyers, have also backtracked.

The Fed’s fight against inflation will not help tackle the nation’s housing deficit. However, putting aside the surge in demand from the pandemic housing boom, the Fed could help restore some “balance” to the market.

4. The housing market correction will soon spread across the economy.

The Fed’s real estate reset isn’t just about housing. It is about taming inflation.

“Housing is a primary transmission mechanism for the Federal Reserve and its monetary tightening is partly intended to cool the housing market as part of the Fed’s efforts to fight inflation,” said Odeta Kushi, deputy chief economist. of First American, a real estate finance service company.

Around the world, central banks are exerting upward pressure on long-term interest rates, including mortgage rates, signaling that short-term rates will stay higher for longer. As mortgage rates rise, home sales and construction go down. This decreases the demand for services such as home loans and removals. It also decreases the demand for raw materials (such as timber) and durable goods (such as refrigerators). These economic contractions then spread to the rest of the economy and, in theory, help weaken the labor market and reduce inflation.

The real estate market has already clearly weakened. However, we are still at the beginning of that weakness that is spreading to the rest of the economy.

5. The Fed’s mandate is not housing.

The Fed has a dual mandate from Congress: to maintain “maximum employment” and “stable prices”. But as long as inflation remains above the Fed’s 2% target, Powell says the latter will be the central bank’s main target. Even if it means pushing the economy into a recession to achieve it.

Ideally, Powell would like to see the Fed real estate “reset” bring us back to a balanced real estate market. Ultimately, however, the Fed’s mandate is not to make sure housing is affordable. If inflation turns out to be sticky, a scenario could be envisaged in which the Fed pushes so hard on the housing market that new construction collapses. If that happens, it will likely send us into the kind of recession that stifles inflation. However, it could exacerbate the nation’s housing supply deficit. It certainly wouldn’t be the kind of balance that would-be buyers are looking for.

“Since April, we have communicated to clients that the Fed’s intentions were to throw demand for housing under the bus, a kind of sacrificial lamb to help keep inflation in check,” says Palacios. Fortune.

Do you want to stay updated on housing correction? Follow me on Twitter at @NewsLambert.

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