U.S Housing: The Impact of Raising Rates

Even though mortgage rates are up 100 points since the beginning of 2023, home prices are likely to stay flat or increase due to tight housing supply.

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Jim Egan: Welcome to Thoughts on the Market. I'm Jim Egan, co-head of U.S. Securitized Products Research here at Morgan Stanley.

Jay Bacow: And I'm Jay Bacow, the other Co-Head of U.S. Securities Products Research.

Jim Egan: And on this episode of the podcast, we'll be discussing U.S. home prices. It's Wednesday, September 13th at 11 a.m. in New York.

Jay Bacow: Jim, mortgage rates are up over 100 basis points since the beginning of the year, but I hear you were turning more optimistic on home prices. What gives?

Jim Egan: Well, the first thing that I would say is that home price data is pretty lagged and that an increase in mortgage rates is not going to be felt immediately in the data. For instance, let's assume the last week of August ends up being the peak in mortgage rates for this cycle. When would you expect that rate to start showing up in actual purchase mortgages?

Jay Bacow: So, if the peak in mortgage rates is the end of August, we will get data on people applying for the mortgage the following week from the Mortgage Bankers Association. But it takes about seven weeks right now to close a mortgage. If the peak was at the end of August, the mortgages are probably closing towards the end of October, almost at Halloween. But if it closes in October, Jim, when will we actually get that data?

Jim Egan: Right. The home price data is even more lagged than that. The Case-Shiller prints that we forecast and that we've talked about on this podcast, those come out with a two month delay. So those October sales, we're not going to see until December. Again, for instance, the print we just got at the end of August, that was for home prices in June.

Jay Bacow: So in other words, we haven't seen the full impact of this increase in rates yet on the housing market and the data that we can see. But when we do, what's the impact going to be on home prices?

Jim Egan: Well, we think the immediate impact is going to be on a few other aspects of the housing market, and then those aspects are going to potentially impact home prices. The most straightforward level here is affordability, right? That's an equation that includes prices, mortgage rates, as well as incomes, and so we're talking about the mortgage rate component. Now, one thing that you and I have said on this podcast before, Jay, is that affordability in the U.S. housing market, it's still challenged, but at least so far this year it really hasn't been getting any worse. That's not the case anymore. Affordability is still very challenged and now it's started to get worse again. By our calculations, the monthly payment on the median priced home is up 18% over the past year, and that's the first time that deterioration has accelerated since October of 2022. Three month and six month changes in affordability have also resumed deteriorating after those were actually improving earlier this year.

Jay Bacow: So if homes are getting less affordable, presumably home sales should fall?

Jim Egan: We think that would be kind of the probable impact there and it is something that we're seeing. To be clear, affordability is not deteriorating anywhere near as rapidly as it did in 2022, and we don't expect the same sharp declines in home sales. But this really does give us further confidence in our L-shaped forecast, and if anything it could provide a little more pressure on existing home sales. But we're also seeing the impact on the supply side of the equation.

Jay Bacow: But wasn't the supply side already incredibly low? For instance, our truly refinanceable index calculates what percent of the universe has at least 25 basis points of incentive to refinance. It's at less than 1% right now. The average outstanding mortgage rate for the agency market is 3.68%. Are we really expecting the supply to fall further?

Jim Egan: So that wasn't part of our original forecast and we had been seeing existing inventories really start to climb off of recorded lows. For context, our data there goes back about 40 years, but that's taken an abrupt about face in recent months. The 13% year-over-year decrease in inventory that we just saw this past month, that's the sharpest drop since June 2021, with a contraction coming through both new and existing listings. As affordability has resumed its deterioration with this increase in mortgage rates, homebuilder confidence actually fell month over month for the first time this year. Now, tight supply should continue to provide support to home prices, even as affordability has become more challenged.

Jay Bacow: And so what does that support for home prices end up looking like?

Jim Egan: The short answer, we expect a return to year-over-year growth with the next print that we're going to get here at the end of September. Case-Shiller year-over-year has actually fallen for each of the past three months. We think that ends now. We have a forecast of plus 0.7% year-over-year with a print that's just about to come out and that would be a new record high. With home prices then surpassing their levels in June of 2022, at least for that index. Our base case forecast for year end has been 0% growth, with our bull case at plus 5%. The evolution of the inputs since particularly the supply point here continues to be tighter than what was already pretty tepid expectations on our part. That has us expecting HPA to finish the year between these two levels, that base case and that bull case level.

Jay Bacow: All right, Jim, it's always great talking to you.

Jim Egan: Great talking to you, too, Jay.

Jay Bacow: And thank you for listening. If you enjoy Thoughts on the Market, please leave us a review on the Apple Podcast app and share the podcast with a friend or colleague today.