The Fed to reset the housing market through a ‘difficult correction’—5 things to know about the plan

“I’d say if you’re a homebuyer, someone or a young person who wants to buy a house, you’re a little bit reset. We need to get back to a place 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 since, economists have openly questioned what Powell meant by a housing “reset.” Does the Fed simply want buyers to pull out long enough for the stock to rise? Or does ‘resetting’ mean that the Fed also wants house prices – which are up 43% in just over two years – to fall?

On Thursday, CNN business reporter Nicole Goodkind asked Powell to clarify what the case “reset” means. here is his long-winded response.

“When I say reset, I’m not looking at any particular set of data. What I’m really saying is that we’ve had a time of red-hot housing across the country where famous homes were being sold to the first buyer at 10% above demand even before they’d even seen the home. Those kind of things. So there was a big imbalance between supply and demand. Houses went up at an unsustainably fast level. So the slowdown in house prices that we’re seeing should help bring prices more in line with rents and other housing market fundamentals. That’s a good thing. For the longer term, we need supply and demand to better match each other so that house prices rise at a reasonable level and at a reasonable pace and people can afford a house again. We will probably have to make a correction in the housing market to get back there. There are also longer-term problems with the housing market. As you know, it’s hard to find lots close enough to cities now, so builders have a hard time getting zoning plans and lots and workers and materials and stuff like that. But from an economic point of view this is difficult [housing] A correction should bring the housing market back into balance,” Powell told reporters on Wednesday.

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While Powell didn’t provide a clear answer, he gave us clues as to where the Fed’s housing “reset” will take 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 entered a cooling mode. While the slowdown started off mild, it has since intensified. On an annual basis, sales of new homes and existing homes are now down 29.6% and 19.9%.

That sharp decline in the housing market isn’t a normalized market — it’s a housing correction. At least that’s according to Powell.

“For the longer term, we need supply and demand to better match each other so that house prices rise at a reasonable level and at a reasonable pace and people can afford a house again. We’ll probably have to make a correction in the housing market to get back to that spot,” Powell said on Wednesday. “This difficult [housing] correction should bring the housing market back into balance.”

This housing correction has of course already started. In May, Moody’s Analytics chief economist Mark Zandi 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 period when the housing market – which was priced at a 3% mortgage rate – would work towards equilibrium. As homebuyers pull back, Zandi says the housing correction will push inventory levels up and decline in home sales volumes. It would also, he said, put much of the nation at risk from falling home prices.

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2. The house correction is putting downward pressure on house prices.

Though Powell didn’t come out to say it, many housing analysts believe the Fed’s housing “reset” is the code for pushing home prices down. An opinion also shared by Fortune.

“Obviously, the Fed’s shift in wording from the ‘June housing need’ to today’s ‘housing reset’ actually signifies a correction,” indicates they’re doing pretty well with falling home prices, cooling home sales and retreating significantly. of construction to achieve this goal is their mission,” said Rick Palacios Jr., head of research at John Burns Real Estate Consulting: Fortune.

We have already seen housing markets across the West slide into house price corrections. According to Zillow, 117 regional housing markets saw home values ​​fall between May 2022 and August 2022. This includes expensive tech hubs like San Jose (-10.6%) and San Francisco (-7.8%). It also includes bustling markets such as Austin (-7.4%), Boise (-5.3%), Denver (-4.3%), Las Vegas (–2.3%) and Phoenix (- -4.4%).

The reason why we are vulnerable to falling house prices is quite simple. The Pandemic Housing Boom sent home prices across the country well above historical incomes. In some markets, such as Phoenix and Las Vegas, it mirrors the levels they reached during the 2000s housing bubble. On Wednesday, Powell told reporters that the housing correction could help balance those fundamentals.

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“The Longer That” [mortgage] rates remain high, our opinion is that housing will continue to feel it and have this reset mode. And the affordability reset mechanism that needs to happen now is enabled [home] Prices. And so there are many markets across the country where we predict house prices will fall by double digits,” Palacios said. Fortune.

3. The housing “correction” broke the fever. That should restore the balance.

This summer, Federal Reserve researchers released a paper: finding that pandemic housing was driven by strong demand, not supply constraints.

“While the supply of new homes for sale fell sharply at the start of the pandemic, we show that the decline in supply was a minor factor relative to increased demand in explaining the tightening of housing markets in the first year of the pandemic.” the Fed researchers wrote. “Our estimates imply that new construction would need to have increased by about 300% to meet the strong pandemic demand.”

The ongoing correction in the housing market has halted that boom in demand. As mortgage rates slumped north of 5%, work-at-home buyers began to question moves into markets like Austin and Boise. Other groups of buyers who helped fuel the Pandemic Housing Boom, such as flippers and second home buyers, also pulled out.

The Fed’s inflation battle will not help address the country’s housing shortage. By putting aside strong demand from the pandemic, however, the Fed could help bring some “balance” back into the market.

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

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

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

Around the world, central banks are exerting upward pressure on long-term interest rates – including mortgage rates – by signaling that short-term interest rates will remain high for longer. As mortgage interest rates rise, home sales and home construction decline. This causes the demand for services such as home loans and moving crews to fall. It also reduces the demand for raw materials (such as wood) and durable goods (such as refrigerators). That economic contraction then spreads to the rest of the economy and in theory helps to weaken the labor market and contain inflation.

The housing market has already clearly weakened. However, we are still in the early stages of that weakness that is spreading throughout 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 focus. Even if that means pushing the economy into recession to achieve that.

Ideally, Powell would like to see the Fed housing market return us to a balanced housing market. Ultimately, however, it is not the Fed’s mandate to ensure that housing is affordable. If inflation proves sticky, one could envision a scenario in which the Fed puts so much pressure on the housing market that new construction takes a nosedive. If that happens, it would probably send us into the kind of recession that wipes out inflation. However, it could exacerbate the country’s housing shortage. That would hardly be the kind of balance potential buyers seek.

“Since April, we’ve been communicating with customers that the Fed’s intention was to contain housing demand, a sort of sacrificial lamb to control inflation,” Palacios said. Fortune.

Want to stay informed about the housing correction? Follow me on Twitter on @NewsLambert.

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