The best way to fight inflation is to have more supply
By Logan Mohtashami
How is today’s housing starts data, which beat expectations, good for mortgage rates? Typically good economic data is bad for rates, especially in this environment, when a Fed member will come out and say building or buying homes is bad for fighting inflation. The answer is simple: The best way to fight inflation long-term is to add more supply.
Destroying demand is a short-term fix, but longer-term supply is the natural economic way. What we see in this latest starts report is encouraging, as a record number of 5-units are still in construction and anything that gets finished is positive against inflation.
As you can see, the 1974 recession destroyed the 5-unit construction production. Like most recessions, when demand falls, so does production. However, unlike the 1970s, when we had a boom in rents, which account for a whopping 44.4% of CPI inflation data, right now we have supply coming online.
I often talk about how today’s economy doesn’t resemble the 1970s, and the bond market never really believed it either, hence why the 10-year yield is below 3.50% today.
Regarding mortgage rates and bonds, since the banking crisis started with a run on Silicon Valley bank last week, bond yields have been heading lower and are now testing my Gandalf line in the sand of 3.42%.
If the 10-year yield closes below 3.42%, we will get more bond buying in the days after that key level breaks and I will feel more comfortable about mortgage rates falling. However, it’s been a struggle to break under this level. As you can see in the chart below, the lovely slow dance between the bond market and mortgage rates has been going on since 1971.
My 2023 forecast puts the range for the 10-year yield at 3.21% – 4.25%, which means 5.75%-7.25% mortgage rates. If jobless claims increase, meaning more people apply for unemployment benefits, mortgage rates and bond yields will go lower.
That isn’t happening right now. Jobless claims and housing starts were both good today and the Atlanta Fed showed 3.2% GDP growth for the quarter.
However, the bond market looks ahead, and the banking crisis here and worldwide is sending money to the bond market for now. We also have to remember Wall Street was heavily short on bonds, meaning that they make money when bond yields and mortgage rates go higher.
However, since the crisis started, they have had to cover their bets and flush more money into buying bonds than normal. This can explain some of the wild actions in the bond market over the last few days.
Earlier Thursday morning, the 10-year yield was at 3.42%, but as I write this article, it’s 3.52%. We will see how mortgage rates get priced in such a wild marketplace.
Housing starts report
From Census: Housing Completions Privately owned housing completions in February were at a seasonally adjusted annual rate of 1,557,000. This is 12.2 percent (±15.0 percent)* above the revised January estimate of 1,388,000 and is 12.8 percent (±16.2 percent)* above the February 2022 rate of 1,380,000. Single-family housing completions in February were at a rate of 1,037,000; this is 1.0 percent (±15.0 percent)* above the revised January rate of 1,027,000. The February rate for units in buildings with five units or more was 509,000.
As you can see, the housing completion data has been a plodding turtle. The COVID-19 lag in production means we have a backlog of homes to get done, although more for the 5-unit space than single-family. The COVID-19 delays have served as a job program here in America, as labor is still needed to finish up the backlog of homes.
Many single-family housing contracts would not have been started if mortgage rates at the day of signing were at 6%-7%. With rates spiking so much so soon, the builders are working off that backlog today. Traditionally, completions would fall with permits, but this is not the case today due to the COVID-19 delays.
From Census: Building Permits Privately owned housing units authorized by building permits in February were at a seasonally adjusted annual rate of 1,524,000. This is 13.8 percent above the revised January rate of 1,339,000, but is 17.9 percent below the February 2022 rate of 1,857,000. Single-family authorizations in February were at a rate of 777,000; this is 7.6 percent above the revised January figure of 722,000. Authorizations of units in buildings with five units or more were at a rate of 700,000 in February.
The decline in housing permits paused in this report, but the trend is still your friend here, as I don’t expect any kind of meaningful rebound in housing permits until the backlog of homes is sold. As you can see in the chart below, today’s data looks different from the massive run-up in 2005 and the collapse.
From Census: Housing Starts Privately-owned housing starts in February were at a seasonally adjusted annual rate of 1,450,000. This is 9.8 percent (±15.5 percent)* above the revised January estimate of 1,321,000, but is 18.4 percent (±8.9 percent) below the February 2022 rate of 1,777,000. Single-family housing starts in February were at a rate of 830,000; this is 1.1 percent (±13.9 percent)* above the revised January figure of 821,000. The February rate for units in buildings with five units or more was 608,000.
Housing starts data itself picked up today, and as always, with housing starts and new home sales data, we have to look back at the revisions, which were negative in this report. However, the recent new home sales data has improved along with builders’ confidence.
Overall, I like the report because it still shows that we will get more apartment supply. The future growth of 5-unit construction will be at risk if a recession happens. However, the key is we have more supply coming, which is the best way to fight inflation.
My rule of thumb for anticipating builder behavior is based on the three-month supply average. This has nothing to do with the existing home sales market; this monthly supply data only applies to the new home sales market, and the current 7.9 months are too high for them to issue new permits.
- When supply is 4.3 months and below, this is an excellent market for builders.
- When supply is 4.4 to 6.4 months, this is an OK market for the builders. They will build as long as new home sales are growing.
- The builders will pull back on construction when the supply is 6.5 months and above.
As you can see below, In the last new home sales report, monthly supply data did fall from 9 months to 7.9 months, so we still have a lot of work to do here to get things back to normal.
On a positive note, the builders are feeling a bit perkier these days. Of course, we are working from a waterfall dive in demand, but it’s still positive that builder’s confidence has picked up.
Home Builder Confidence Index
This week’s housing starts and builders’ confidence report are positive for the future of mortgage rates. We are seeing inflation being fought in the right way with supply and lower mortgage rates, which means future housing production might be better than some thought once the backlogs are done.
Logan Mohtashami is a housing data analyst, financial writer, and blogger covering the U.S. economy specializing in the housing market. Logan is also a Lead Analyst for HousingWire. Mohtashami has been an invited speaker at the Americatlyst, the California Association Of Realtors, and many other economic conferences. Logan Mohtashami, now retired, has been called a social media star by National Mortgage News and “the chart guy.” Mohtashami’s astute analysis of economic data and years of direct lending experience allows him to present a unique, informed, and unbiased perspective on the financial markets.