The housing market is full of surprises. Sentiment among homebuilders has been perking up, their stocks are surging, and new home sales are at the strongest since early 2022. All in the face of persistently high mortgage rates.
Builders are benefiting from an unusual confluence of factors: Homeowners, locked into historically cheap loans, have been reluctant sellers, squeezing re-sale inventory and pushing buyers toward new constructions. This rapid turnaround of the past six months will extend the surprising strength we’ve been seeing in the economy as renewed building activity starts to flow into the gross domestic product data.
Residential investment should start to give US economic growth a boost in the second half for the first time since 2021. That means worries about a long-anticipated recession can be pushed out to next year.
One way to think about this fresh spurt of activity is to see how it worked on the way down. Housing detracted, on average, around 1% from real GDP growth between the second and fourth quarters of 2022, but the leading indicators of weakness showed up earlier. The iShares US Home Construction ETF fell about 28% in the first quarter of last year. The National Association of Home Builder’s monthly sentiment survey capturing future sales slid from 85 to 70 during that stretch — still above 50, indicating an expansion, but a sign that storm clouds were looming.
And while new home sales were still holding up, there was, importantly, a deterioration in the composition of the data. The sale of new houses that hadn’t yet been started fell to its lowest level in nearly two years in March 2022. That shrinking pipeline for future construction was a sign that there would be less demand going forward for things like labor and building materials that mark the start of a building cycle.
Tuesday’s new home sales report showed how long ago that now seems in this quickly changing housing market. The overall number jumped, with particular strength for homes where construction hasn’t yet begun, which saw one of the biggest monthly increases on record.
This improvement has not yet shown up in the GDP data due to the way the recovery has unfolded. Last year, builders were busy selling through inventory they already had before starting any new projects. Single-family housing starts, which began declining last Spring, hadn’t shown much improvement as recently as this April.
There are now signs of a change. New construction of single-family homes jumped in May to the highest level in nearly a year, while purchases of of previously owned homes dropped given the constraints on inventory. Homebuilder KB Home said in an earnings conference last week that it expects to “ramp up” new projects in the third quarter. All this activity will lead to renewed demand for labor and building materials, which fell off so noticeably in the second quarter of 2022.
Housing is about to shift from a headwind to a tailwind when it comes to GDP. That's significant when thinking about recession risks.
In the past 40 years, there have been 12 quarters in which real GDP growth fell by at least 1% on a seasonally adjusted annual basis. In nine of those, residential investment detracted from GDP growth. In addition, the first quarter of 2020 reflected a shutdown of the pandemic-hit economy. In short, it’s very difficult for a recession to unfold when housing is boosting economic growth, given the importance it holds in the business cycle, unless some other significant part of the economy is collapsing.
And while we shouldn’t give the economy the all-clear when the Federal Reserve still intends to raise interest rates this year to tame price pressures, housing construction cycles last for more than just a month or two. Even if housing demand stalls later, the building uptick underway should boost GDP growth for at least a couple of quarters, and likely longer.
That means the elevated recession risk that forecasters have penciled in since this rate-hike cycle began in early 2022 has most likely been pushed out yet again. Wall Street's initial response has been to cheer this news — in recent weeks technology stocks, housing-related stocks, and cyclically-sensitive stocks such as those in the travel sector have all rallied on signs of resilient economic growth. But that’s also put more aggressive policy tightening by the Fed back on the table. So long as the central bank's inflation fight continues, so will the guessing game around the next recession.
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