Housing Strengthening and CPI Softening

By Lyon Wealth Management on July 13, 2023

Consumer Confidence Reflected in Housing Market Activity

While homeowners are holding onto their low mortgage rates, new home buyers are absorbing higher interest rates, as mortgage applications have risen in 2023. In May, new home sales reached the highest level since February 2022 and housing starts reached the highest level since April 2022.

Positive housing activity corresponds to a pickup in consumer sentiment. 30-year fixed mortgage rates are averaging 8% – a combination of higher real income and low unemployment is adding to affordability, despite the higher rates. Confidence across home builders and home buyers has improved this year, and the traffic of prospective buyers of new homes has ticked up sharply this year.

Chart 1: Mortgage Applications Beginning to Follow Better Sentiment¹

Limited housing inventory is also driving an upward swing in prices as demand picks back up. This reinforces confidence across home builders as we continue to see low vacancy rates and added traffic.

Chart 2: Home Prices Reversing Trend as Demand Gains Momentum²

The housing market is a major contributor toward broader economic growth, as home buyers also purchase goods and services as a part of home buying. The auto market is highly correlated with housing, and in the latest rail traffic data, automotive traffic increased +17% as dealerships re-stock to meet demand.

Housing Market’s Interest Rate Sensitivity … or Lack Thereof

The housing market tends to be one of the most interest-rate-sensitive sectors. Shortly after the Fed shifted its monetary policy, housing was really the first sector to feel the impact. Mortgage rates increased and demand fell sharply. Interestingly, despite rates continuing to move higher, the industry is rebounding strongly.

How can demand be picking up without rates coming down? Much of this effect has to do with the strong labor market. Higher real wages and increased consumer confidence are driving potential home buyers into the market. In addition, the U.S. is 5 million homes short in housing. There are now 5 million millennials who are first time buyers, which is also adding to the demand. 

The Fed had previously hoped that a softer housing market would support its fight against inflation. The data indicates that housing market weakness has troughed. Further, the higher mortgage rates have reduced housing inventory – largely due to a drop in existing homes available on the market. There were 33% less existing homes available for sale in June 2023 than in February 2020.³

The latest inflation data continues to highlight housing as a contributor toward elevated inflation. While better housing activity may not slow inflation, it represents nearly 20% of U.S. GDP.

CPI Softer Than Expected

U.S. headline CPI cooled in June to 3% y/y, the slowest rate since March 2021. Core CPI also retreated to its slowest rate since November 2021, but remains elevated at 4.8% y/y.

Service sectors continue to drive inflation – shelter-related prices were the largest contributors to CPI in June. The housing rebound could add to persistent core inflation.

Fed Chair Jerome Powell has referenced his focus on core services, excluding housing, which decelerated to 4% y/y in June, although was little changed from the prior month.

Yields fell and stocks rallied on the CPI print. The next Fed FOMC meeting is July 26. We expect a 25 bps increase as Fed members remain hawkish and resound in their fight against inflation. The Fed’s CPI target is 2%. The trend is supportive that we are near the peak fed funds rate.

Chart 3: Annual Inflation Pace Retreating⁴