HIGHER RATES WILL WEAKEN the Strong Start for 2023

BY: ROBERT DIETZ

The housing market benefitted from retreating interest rates in January. Unfortunately, the recent rise in rates due to the last stages of Fed tightening, coupled with ongoing tight labor market conditions, will weaken housing demand in the coming weeks before stabilizing later in the year.

The 10-year Treasury rate started the year at 3.9% and then fell to 3.4%, as the bond market briefly adopted a dovish view of future monetary policy conditions. As a result of this move, mortgage interest rates declined from 6.5% to 6.1% by the end of January. Demand for mortgages increased 3% and refinance demand jumped 17% week over week at the end of the month. Additionally, home buyer traffic improved, according to the NAHB/Wells Fargo Housing Market Index (HMI), helping to produce a second monthly gain for the index in 2023 — after 12 straight declines in 2022. The HMI’s rally to a level of 42 was also thanks to the rate decline and ongoing use of sale incentives.

However, those lower rates have given way in February. The 10-year Treasury increased to 3.9%, and the average 30-year fixed rate mortgage will rise to approximately 6.7% in the coming week. These higher rates are due to ongoing elevated readings for inflation, with the Consumer Price Index (CPI) up 6.4% year over year in January. This is an improvement since the CPI peaked at approximately 9% in June 2022. Producer price growth remains elevated as well. For instance, residential construction material growth is up 5.1% from a year ago as of January, with concrete prices up more than 13% since the start of 2022. An NAHB survey of builders’ top challenges found building material costs were, for the second year in a row, the most significant concern for the prior year.

Higher rates and expanding construction costs mean the market is weak, despite the January uptick, and will likely remain so until later this year when a building rebound will take hold. Single-family starts decreased 4.3% in January to an 841,000 seasonally adjusted annual rate, down 27% from a year ago. The multifamily sector decreased 4.9% to an annualized 468,000 pace for 2+ unit construction in January. On a yearover-year basis, multifamily construction is down 8.1%, with additional declines forecasted. And a near-decade low for housing affordability, per the NAHB/Wells Fargo Housing Opportunity Index, means ongoing weakness for existing home sales, which saw its 12th straight monthly decline in January.

While the near-term outlook for interest rates — combined with additional rate hikes from the Fed — suggests weakness for sales and permits for at least the next two months, the uptick in the HMI and the steady, though modest, improvement for the inflation outlook suggest a turning point for single-family construction taking hold mid-year or in early fall.