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The Chase is On
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Demand: New Normal Setting In
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Supply: Still Nada
Denver is approaching the height of its summer buying season, and volume is still not picking up. Thank you, “High Plateau.” Colorado (and the broader country) is facing a massive problem in that a generation of homeowners is now locked into their homes at extremely low mortgage rates, and the generation trying to form households can’t afford to buy what’s on the market. To make it worse, the inflation problem is still creating issues for the Fed which means mortgage rates aren’t likely to go down anytime soon. Following Jerome Powell’s press conference on June 14th, it seems more likely higher borrowing costs will persist across the curve for longer than people are expecting. This month’s discussion will focus on the current macroeconomic picture and its impact on Denver’s housing market.
The Chase is On
You should check your 401k and retirement balances. Following the resolution of the debt ceiling by Congress (at the last minute…), the equity markets have been on FIRE. Heading into the year, “everyone” (including yours truly) was extremely bearish on the state of financial markets given the numerous Landmines that were out there — higher interest rates, the debt ceiling, poor earnings momentum, commercial real estate, etc. etc. etc. As a result, it seems the only thing the market needed to rally by more than 20% from October’s lows was simply surviving.
We have to bear in mind, however, that equity market values are not true indicators of what’s happening in the economy right now. Last week, on June 14th, the Fed announced their most recent rate decision in which they declined to change overnight rates, and Jerome Powell, the Chairman of the FOMC, suggested in his press conferences that multiple hikes are likely back on the table later this year. This should have been bad news for the markets, but it wasn’t. Futures handicapping the long-term path of the Fed’s rate decisions were implying CUTS over the next several months rather than HIKES, and yet, the S&P 500, Nasdaq, and Dow Jones are up materially higher since that announcement.
Powell (and the rest of the FOMC) are trying their best to navigate a very, very difficult maneuver. By all of the Fed’s preferred metrics, inflation is still WAY too high, and the impact of the rate hikes has not had the desired effect, yet. The FOMC’s goal is to have inflation around 2.0% and we’ve been registering over 4% based on the PCE deflator for several months; one could make a further argument that inflation is trending back higher, too. He knows that commercial lending is tightening and there are a lot of loans out there right now which won’t be renewed or would need to be refinanced at dilutive rates. He also knows there is a 6-9 month lag from when the Fed raises rates until the impact of that raise is seen. However, the labor market hasn’t really slowed down, wages are still going up at a material pace, and the lack of a crash in the housing market is keeping inflation rather sticky. Powell and the rest of the FOMC members are trying to raise rates to the point where things slow down and not too much where the economy starts to break…
The more the equity markets rally ahead of what seems to be further tightening, the less likely it will become the economy will slow down without breaking. Higher equity values do contribute to higher inflation as public companies can borrow/structure based on higher market values and this generates more demand for goods & labor. More demand for goods & labor = higher inflation. Ironically, the longer the equity markets rally, the more likely it is that the Fed will have to be more heavy-handed. On the other hand, if there is a major equity market selloff, we might find ourselves in a situation in which the medicine might be worse than the disease. A recession would definitely bring inflation down, but it would be much, much harder for the Fed to come back in to stabilize the economy with liquidity given a few structural inflation pressures that will persist.
Over the next few months, the US economy is going to want to see data that suggests the following: (1) inflation trending lower, (2) high but not material job losses, and (3) lower retail sales and consumer spending. If there is a way for this to happen without companies coming out en masse to guide earnings lower, then everything should be OK! Otherwise, we’re going to be in for a change in sentiment.
Demand: New Normal Setting In
& Supply: Still Nada
Let’s check in on our trusty table summarizing the current conditions in Denver’s housing market within a 10-mile radius around downtown:
As the summer buying season continues, we’re gathering more data that suggests the market is overall slower due to affordability. High interest rates are definitely impacting potential buyers’ ability to afford homes at current prices, and that phenomenon is what’s causing downside pressure on the market. On the flip side, supply continues to come on to the market at a slower pace and lower levels of supply are keeping prices elevated. Even though demand is shifting lower, there are few enough homes on the market to support current prices. This is shown by the relative strength in pricing in May vs. April — the price of an average sold unit was down only 1.6% vs. the -5.5% registered in April. The market is lower in both cases and “less bad” in May due to more supportive supply & demand characteristics.
We find it encouraging that the spread between appreciation in average list prices vs. sales prices is coming back to a more reasonable level. Last September, there was a 13% spread between sellers’ expectations and the market’s clearing price; now, that spread is down to 4-5%. The decrease in the spread can be attributed to faster declines in average list prices rather than gains in sales prices which suggests that sellers are getting the message about affordability issues. This is consistent with the feedback we’ve given our clients over the last several months: if you want to sell your home for the highest price, you have to price it properly when it hits the market. We are seeing bidding wars over homes that come on the market at “reasonable” prices because “affordable” homes are hard to find right now. On the other hand, homes that are off-the-market by are little bit are sitting and losing pricing leverage as time goes on.
Both our home & loan teams are seeing continued interest to start the buying process, and that is slightly encouraging that fall and winter might not be as slow as last year — this will also be helped if the spread between list & sales prices continues to decrease. The problem is getting people qualified at today’s current combination of prices and rates.
So what happens going forward? Probably more of the same. Skip to the bottom if you want to see some good news.
The US Fed won’t be happy until the green line gets back to something A LOT closer to 2.0% — currently, it’s about 4.5%. After all of the interest rates hikes and tightening of lending standards, it’s understandable why the Fed would have expected a greater slowdown in demand to cause a decrease in inflation, but that decrease hasn’t quiet happened, yet. (This is why Jerome Powell put interest rate increases back on the table at his press conference last week.)
But won’t higher short-term increase rates likely create a higher chance of an economic slowdown? Yes. But… if he doesn’t raise rates and inflation stays at 4.5%, then the market is going to have to adust rates higher for him. US interest rates are always a bit lower because it’s the biggest debt market in the world and can handle most of the world’s demand for reserve assets and the fact that our real interest rates are relatively close to zero while over, developed economics are still stuck in negative real rates environments. If the Fed stops while other countries continue to fight inflaton, then money will flow out of treasuries to other countries with better rate differentials and this will cause an increase in US interest rates and a weakening of the US dollar. There are two problems with letting this happen in the market: it would be uncontrolled and the weaker dollar would increase inflation thus forcing higher rates.
There’s a really good argument to be made that it’s better to let Powell and the FOMC get a bit tougher on the inflation fight to ensure they can keep the ball in their court when it comes to having the tools to manage the US economy. Losing the market’s trust is not an option.
This is why we believe interest rates are more likely to stay at current levels or even go higher from here rather than decrease. This will continue to put pressure on affordability at current prices and will likely slow down the market until prices slowly drift lower as well. In a situation in which interest rates go lower, it’s our opinion the cause would be a pretty serious recession which is preceded by accelerating job losses (we’re not there, yet, don’t worry). In this case, prices would come down as homes would be sold to monetize equity and the workforce rebalances. Either way, it’s hard to see how there’s a reacceleration in price gains to the extent we saw over the last few years and think it’s more likely the market continues to slow down in some way, shape, or form.
The good news is that our BLUE PEBBLE LOANS program is WORKING to combat this affordability crisis. Our clients are actively saving 5-10% on their monthly payments when they apply their commission rebates to purchase discount points on their loans and get lower rates. As a result, they can win bidding wars, save money to pay for higher property taxes & insurance costs, or just buy a bigger home!!
For those clients who might be looking to get some cash from their homes without selling, our lender is also able to look at reverse mortgages, refinancing, and HELOC solutions! Click HERE to fill out a loan application and find out how much our team can save you every month!