Runaway Train
Do these brakes work?
Demand: We’re Back, Baby!
Supply: Marco… Polo…
Now that Taylor Swift left Colorado, it’s time to get back to business. The jobs market, as shown in the ADP Payroll and Non-Farm Payrolls reports, doesn’t appear to be slowing down at all. And while this is a good thing for most families, it is making the Federal Reserve’s job much, much harder. Average wage gains registered more than 4% year-over-year and this is a leading indicator for higher inflation. Additionally, there will not be any forced selling in the residential market without broad job losses, and that makes the short-term outlook for housing affordability worse. While there was a bit of a reprieve in borrowing costs after the most recent inflation report, the US bond market is reacting to primarily stronger economic news by driving interest & mortgage rates higher. At the same time, buyers are getting more comfortable with higher rates, and we’re seeing demand start to pick back up again which means higher prices are also here to stay for a bit.
The current environment is proving our integrated brokerage model in which we can eliminate unnecessary middlemen and pass significant savings to our clients. Our buyers can increase their purchase prices while lowering their monthly payments in this crazy environment – give us a call to see how much you can save.
Do These Brakes Work?
It’s been a volatile few weeks in the fixed-income markets where US treasuries and mortgages are traded. The main drivers of this market are changing expectations around the path of short-term interest rates as set by the Federal Reserve, and there are sizable moves when data comes out that shifts the market’s perceptions of what’s happening.
Prior to the release of Consumer Price Index (CPI) data earlier in the month, the US 2-year note yielded over 5.0% and the 10-year note breached 4.0%, both near the highest levels seen in the last 20 years; it was the market’s expectation that the Fed was going to have to keep its foot on the gas peddle through the end of 2023. With the release of the most recent CPI data in which the headline and core numbers were slightly lower than the market’s expectation, the market shifted quickly. Both short and long-term interest rates are off their highest levels, and there seems to be more hope that the Fed is done hiking interest rates. If this is true, then it’s likely we’ve seen a peak in short-term rates, and this would be somewhat constructive for risk assets (including real estate).
The market’s concern is shifting from handicapping the highest level of interest rates to the duration for which rates will stay high. (And based on my recent conversations, it seems that the following perspective isn’t a super popular one at social functions right now…) It’s relatively easy to solve inflation caused by printing money through the pandemic – raise rates, get the money out of the system, deal with a minor recession (or not?), and move on. The inflation the Fed is now trying to solve, however, is much, much more difficult, and it will test the Fed’s resolve in getting back to its 2.0% long-term target. There are a number of demographic and geopolitical issues causing inflation that are not nearly as responsive to the Fed’s actions including (1) an aging global population, (2) deglobalization, and (3) Millennial & Gen Z household formation. An aging global population is a problem because “older people” have all the money, will continue to consume, and can no longer offer material labor to support their demand. This is the main reason why wages continue to go higher every year. At the same time, the Millennial & Gen Z cohorts are starting to form households and families which is also increasing their demand for goods. It’s hard to see how these pressures will alleviate without a major shift in demand that hasn’t happened, yet. At the same time, there is a trend internationally towards deglobalization. The process of rerouting supply chains and onshoring manufacturing will go on for years and will increase costs at the most basic levels of goods for some time to come. All of these reasons are probably why the Fed hasn’t come out and declared victory in their inflation battle, yet.
The end result is that we expect rates to stay higher for longer, and this will keep the cost of housing extremely expensive. Any decrease in long-term interest rates will be met with a wave of demand from buyers who can’t afford current prices, thus keeping the net cost of housing extremely high.
Demand: We’re Back, Baby!
Supply: Marco… Polo…
Let’s check in on our trusty table summarizing the current conditions in Denver’s housing market within a 10-mile radius around downtown:
Residential market data for area within 10-miles of Union Station in Downtown Denver as of July 18, 2023
We’ve “felt” the market changing over the last few weeks, and the data is suggesting that our anecdotal experiences were consistent with what is happening in the market right now. There are three interesting shifts to note this month: (1) now fewer active listings than last year, (2) a pick-up in pending activity, and (3) a reacceleration in prices.
Fewer active listings and the pick-up in pending activity are definitely related to each other. As you can see on the far lefthand side of the table under “New Listings,” you can see that fewer listings have been hitting the market for quite some time now. One of the main reasons why Days on Market (DOM) spiked in the winter with a decrease in home values was that there were double the active listings on the market while market activity (via Pendings) was down significantly.
In the last month, however, it seems that we’ve flipped to now having LESS supply on the market now than at this time last year AND pending activity is “less bad” as it approaches a zero percent decline. There isn’t any economic or market occurrence that would explain this shift in behavior; our best guess is that after several months of putting off plans, clients now feel pressure to start testing the market. Additionally, there’s been an abundance of press in the last several months arguing that interest rates won’t come down as quickly as people thought, so many people are a lot more comfortable with a 7% mortgage than they were six months ago. What makes this shift even more interesting is that demand tends to have peaked by June, and we would normally expect pending activity to go down into the end of the year. We did not see June as a materially worse month for absorption this year, and July seems to be off to a strong start as well.
The reacceleration in prices is fascinating and goes contrary to everything that should be happening in this higher interest rate environment. The three months leading up to June saw declines in the average price of a sold unit in our market area and that made a lot of sense. The market in 2021 & 2022 forced buyers to max out their budgets, so when borrowing costs increased faster than wages, it followed that buyers could not afford the same prices as the year prior. Therefore, the reacceleration in the average price of a sold unit in the absence of huge wage gains is fascinating. We’re back to only ~6 weeks of inventory on the market, DOM is still below 7, and buyer demand is accelerating… No supply + higher demand = higher prices. How long this phenomenon lasts is something that we can’t predict… We would expect a lull at some point this winter, but who knows when that might happen if buyers are trying to get something done before the end of the year.
