The housing market is a relative bright spot for the economy. Rising mortgage applications, positive home building indicators, and an increasing focus on the importance of “home” are strong supports for the housing industry in the emerging recovery.
Why is housing positioned in this leading role? Relative to the Great Recession, housing enters this recession underbuilt rather than overbuilt. There is no wave of vacant homes to depress home prices, so the housing finance system is in relatively solid shape. Demographics are a tailwind for housing demand, with a large number of millennials looking to move from renting to homeowning as they age into their 30s. And, of course, housing is benefiting from low interest rates.
With respect to rates, the Federal Reserve controls monetary policy in the United States. In chairman Jerome Powell’s words, the Fed’s powers lie in the realm of “lending, not spending.” In other words, while fiscal policy (tax/government spending) is controlled by Congress and the president, the Fed sets the stage for the financial system by determining the short-term federal funds rate. Since March, this rate has been effectively zero. Moreover, the Federal Reserve has restarted quantitative easing, or the purchasing of Treasury bonds and mortgage-backed securities, which holds interest rates low.
The combination of these policies has lowered the 30-year fixed mortgage interest rate to an average of less than 3.2% as of June. While mortgage qualifying criteria are tougher and prospective home buyers continue to be challenged by down payment requirements, low interest rates are undoubtedly a bullish indicator for home buyer demand and future construction needs.
Of course, the Fed’s actions have not just benefited the housing sector. The Fed’s quick actions in March prevented a liquidity crunch, which could have quickly become an overall solvency crisis for business and the economy. Additionally, through the creation and operation of new liquidity facilities, the Fed has provided resources to state and local governments during the period of maximum economic stress.
Ironically, the Fed’s quick and aggressive actions are likely a result of the central bank’s errors in 2018. Prior to the virus recession, the Fed raised interest rates too fast, which increased mortgage rates and threatened to stall the housing market due to affordability headwinds. In 2019, the Fed course-corrected, implicitly acknowledging the error of tightening during a period of little inflationary pressure. This put the institution in a place where it felt that it could aggressively ease due to the public health crisis of 2020, without short-term concerns over inflation.
Future monetary policy challenges still exist. As the recovery takes hold, the central bank will need to determine how to roll back the pace of quantitative easing. And, eventually, the growth of the Fed’s balance sheet and the size of the national debt will increase inflation. Such maneuvering will wait, however. The NAHB policy forecast specifies that the Fed will not raise the federal funds rate until the unemployment is below 5.5% and inflation is persistently above 2%. Those economic conditions are not likely to be met until 2022, meaning accommodative monetary policy will support housing, home building, and the overall economy for years to come.
