How Does The Economic Forecast Affect the Future Housing Market?

Economists are saying recession is on the near horizon. Bloomberg’s July 2022 survey of economists found the probability of a recession within the next 12 months is 47.5%, up from 30% in June, and from just 20% in March, as consumers and businesses grapple with costs racing ahead of wages. Citigroup, Deloitte and PNC Financial Services previously predicted a slowdown in 2023, but recent forecasts say a recession could occur in 2022. Bank of America and Wells Fargo are both predicting a mild recession in 2022 and the first quarter of 2023, respectively.

The culprit this time is economic inflation, which rose 9.1% year-over-year in 2022 on the shoulders of record housing prices, wage increases, higher interest rates, and continuing supply/demand imbalances across many industries, including housing.

So what will set the coming recession in motion? DallasFed.org explains that if a recession is defined as two consecutive quarters of economic contraction, with a real decline in gross domestic product, we could already be in a recession, except for some unusual contradictions. In Q-1, 2022, the national GDP fell 1.6 percent on an annualized basis, followed by a 0.9 percent drop in the second quarter. But there are strong indicators that the U.S. did not go into recession because of positive economic factors, including low unemployment and sustained consumer spending. But that could change.

Definitions of recession vary, but are officially declared by the National Bureau of Economic Research, (NBER) which defines them as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.” The form recessions take also varies, according to Economicshelp.org:

• Boom and bust recessions are caused by rapid and high growth that triggers inflation. Recession begins as interest rates rise and ended as rates are lowered again. (Technology bust, 2001, Tulipmania, 1634-1637)
• Balance sheet recessions are caused by the lack of available credit when banks and firms see a large decline in their balance sheets due to falling asset prices and bad loans. (Savings and loan crisis, 1986-1995, Great Recession, 2008)
• Supply-side shock occurs when a commodity like oil rises exponentially in price, causing consumers to curtail spending. (oil embargo, 1973, Iranian revolution, 1979)
• Depression is a significant decline in the gross domestic product that may take years to recover. (Great Depression, stock market crash, 1929-1946.)

However, explains that NBER uses other data before acknowledging a recession– depth, diffusion and duration. As calculated by Forbes.com, we’ve met the criteria for duration with six months of declining gross domestic product. The depth of decline so far is about 1% to 2%, which is shallow by the significant declines of 5% or more in previous recessions. Diffusion measures how well sectors of the economy are doing, and currently travel and energy are doing relatively well. These are the reasons NBER hasn’t called a recession as of yet.

Housing sales are starting to slow down from feverish levels, but remain far from what is considered a balanced market in the sector. NAR reported in August 2022 that existing-home sales fell for the sixth consecutive month in July, down 5.9% from June. Housing prices are up 10.8% from year-ago levels to $403,800, but are down $10,000 from June’s record high of $413,800. Supplies of homes rose in July, with 3.3 months of inventory at the current sales pace. In any context, 3.3 months of supply on hand is not enough to meet demand which is why housing prices remain stubbornly high. Six months’ supply is balanced and favors both the homebuyer and the seller equally in negotiations. 

If we apply the depth, diffusion, and duration model to housing, there’s still a long way to go before homebuying is in recession. With prices dropping only one month from a record high, we don’t have depth. We don’t have diffusion because there isn’t enough supply to determine what types of housing are in decline. We only have duration in sales volume which could also be related to supply as well as rising mortgage interest rates. If rates fall, the sales pace and price gains should continue due to lack of supply. Housing could be in “stagflation,” a period of declining growth and high inflation.

TheBalance.com notes as many as twelve causes of recessions:

1. Loss of Confidence in Investment and the Economy. When consumers stop buying, businesses order fewer supplies, and jobs begin to disappear.

2. High-Interest Rates.  The Federal Reserve raises interest rates to protect the value of the U.S. dollar, but it also limits the ability of consumers and businesses to borrow and invest.

3. Stock Market Crashes. This is a sudden loss of confidence in investing, which creates a “bear market” and drains businesses of capital.   

4. Falling Housing Prices and Sales. No one wants to catch a falling knife, and when homeowners can’t tap into their equity, homebuyers lose confidence.  

5. Manufacturing Orders Slow Down. When businesses pull back in the same way consumers do, this is a predictor of recession.

6. Deregulation. Sometimes the government does the wrong thing to encourage commerce by removing safeguards that prevent speculation.

7. Poor Management. When banks do the wrong thing such as provide questionable loans to borrowers or commit fraud, it’s a sector with enough strength to take down the economy.   

8. Wage-Price Controls.  The law of unintended consequences can come into play when the government tries to stop inflation the wrong way. In 1971, President Nixon froze wages and prices, but employers laid off workers which led to the 1973 recession.

9. Post-War Slowdowns. With no further need to provide goods for the military, manufacturing slows down which causes recession.

10. Credit Crunches. When banks stop lending because of overinvestment in hedge funds or other areas, businesses and consumers suffer. 

11. When Asset Bubbles Burst.  When assets like gold, stocks or housing cost more than their sustainable value, consumers stop investing and recessions occur.

12. Deflation. When prices fall over time, it encourages consumers to wait for the bottom which causes recessions and depressions. This occurred for nearly a decade after housing collapsed in 2008, forcing it to continue flattening.  

If a recession comes, what will it do to the housing industry? Whatever happens won’t be typical. Everything about the current economy and housing is anything but.

Savings rates are down and credit card debt is increasing as consumers grapple with inflation. Interest rate hikes are already having an effect in bringing down runaway inflation numbers, but they also limit homebuyers from borrowing enough to pay for near record-high home prices. Yet homes are still selling at a blistering pace, staying on the market for as little as 14 days. CNBC.com points out that home prices have soared nearly 36% since the pandemic began just over two years ago, so a 2.4% one-month decline could be a market adjustment instead of a decline in value.  Housing prices are expected to rise 11% for 2022 and 2% in 2023, according to NAR’s most recent forecast. Freddie Mac and Fannie Mae also predict slower but positive price growth in 2022 and 2023.