Viewpoint
June 21, 2024 | 13:49
June 21, 2024
Economics
Economics
Economics
Economics
Economics
Economics
A Renewed Homebuilding Slump Emerges |
| Add one more important element to the downside growth risks for 2024: homebuilding. Despite copious media stories of a general lack of housing supply and never-ending home price gains, we instead see renewed signs of fading housing demand that have homebuilders increasingly pulling back on their current and future building plans. New single-family home sales in April were down 7.7% from a year ago after a brief spurt higher last summer. The drop in sales looks sustained and not a one-off event as a clear downtrend in housing demand appears to be re-establishing itself. This lack of housing demand is corroborated by the June NAHB Housing Market Index that shows a decline into contraction territory of the present and future sales indexes, along with a lackluster buyer traffic index (Chart 1). This is in line with our forecast for slower GDP growth and a more cautious consumer in 2024. |
| Yet, homebuilding stocks have fared well so far this year as 30-year fixed rate mortgages retreated from their October 2023 highs of over 8.0%. Investors, anticipating Fed rate cuts and lower inflation rates over the next several years, are positioning for better days ahead for homebuilding. But those investors might have to wade through a renewed building slump before they reap their rewards as the Fed drags its feet on rate cuts this year and consumers get increasingly pinched as the Fed tries to wring out the last vestiges of inflation. First, it’s important to realize that homebuilding has been in a slump for a while now, really ever since the Fed started hiking interest rates in the first quarter of 2022. Given the housing starts plunge for May reported earlier this week, we now expect total housing starts to contract in the second quarter by 6.3%—this is on top of a steep 5.0% decline in Q1. In fact, housing starts have contracted now in seven of the past nine quarters. The epicenter of the homebuilding decline is clearly in the multi-family space where starts (5 units or more) trailed last year’s pace by a whopping 51.7% in May; but single-family starts are fading too, contracting 1.7% from a year ago, their first year-on-year decline since June 2023. Yet, months' supply of new homes continues to surge to 9.1 months even with the contraction in housing starts well underway (Chart 2). With building permits now down 9.5% from a year ago, it appears a residential construction rebound in 2024 is being put on hold. |
In light of weaker-than-expected homebuilding for May, we are scaling back our housing starts forecast to reflect the reality of a higher-for-longer Fed and the impact restrictive monetary policy is now having on the housing market. Even if the Fed starts easing rates in September, average housing starts this year (forecast at 1.38 million) will likely still fall 2.9% short of the 2023 average of 1.421 million, and a true recovery in homebuilding won’t occur until 2025. |
America’s Soft-landing Consumers |
| After back-to-back quarters with annualized growth topping 3% to end last year, real consumer spending slowed to 2.0% in Q1. This week’s weaker-than-expected retail sales results for May, and the downward revisions to April, suggest Q2 could be at least a little slower still. Swayed by the confluence of dogged growth headwinds and faded or continuing tailwinds, consumer spending is decelerating moderately, on course for 1%-ranged real growth (one definition of a ‘soft landing’). High inflation and interest rates have been relentless headwinds for consumer spending but, until recently, their impacts have been meaningfully muted by the drawing down of excess savings. Meanwhile, record high net worth along with slower but still-expanding real wages and salaries are helping steer spending well clear of contraction. Inflation erodes the purchasing power of income, resulting in less real outlays, other things equal. For consumers whose incomes have not kept pace with prices, inflation has had (and is having) a contractionary impact on their spending volumes. However, this is not the case for consumers in aggregate. Since immediately before the pandemic, consumer prices have risen a cumulative 17.7% according to the PCEPI (the CPI is up 20.8%). Meanwhile, disposable personal income has grown 25.3%, resulting in a 6.4% total rise in real income, which translates to a 1.5% annual rate. Other things equal, including the propensity to consume, this would have led to 1.5% trend growth in real spending. (But other things were not equal and real spending expanded at a 2.5% annual rate.) Given income growth, if inflation was even higher, this would have led to slower growth in real outlays. Higher interest rates are a drag on consumer spending, specifically for outlays typically financed by loans, but also, generally, as more funds are diverted to servicing debt. The Fed started raising policy rates in March 2022, lifting the fed funds target a total of 525 bps to a 5.25%-to-5.50% range by July 2023, where it’s held since. This, along with quantitative tightening (beginning in June 2022), left a legacy of high borrowing costs for consumers ranging from credit cards and prime rate-based loans to auto loans and 30-year fixed rate mortgages. However, the aggregate debt service ratio (total payments as a percent of disposable personal income) hasn’t moved that much since rates started rising (Chart 1). It stood at 9.80% in 2023Q4, up 31 bps from where it was in 2021Q4 (the period before the Fed first hiked rates). Indeed, since 2012, the ratio has remained relatively stable, in the 9.7%-to-10.3% range, apart from during the pandemic period (2020-2021) when disposable personal income was whipsawed by repeated support measures. And, when 30-year mortgage rates plummeted to their lowest levels on record and refinancing activity surged to decade highs. The relative stability of the debt service ratio reflects the same for the debt ratio (total debt as a percent of disposable personal income), which currently sits at 85.4% (based on the New York Fed’s tally). Apart from the whipsawing pandemic years, this is among the lowest levels in more than two decades. In the wake of the Great Recession and Global Financial Crisis, and the regulatory changes that ensued, consumers are borrowing within their means (and lenders are lending as such) keeping both debt and debt service better aligned with income. |
| However, this is not to say that high interest rates aren’t dampening consumer spending. The surge in mortgage rates, for example, contributed to a reduction in the demand for homes and, with it, in the spending on goods and services typically associated with housing market churn. And, for household budgets already constrained by inflation, higher debt service payments probably spurred further curtailment of spending (let alone rising loan delinquencies). High interest rates and fast inflation have turned out to be more headwind than hurricane for consumer spending (so far), mostly because of the draw down of excess savings. This permitted spending to continue at a sturdy pace, despite rising prices and borrowing costs. It also prolonged the Fed’s fight against inflation. In response to the pandemic, governments provided lots of support to families and individuals (e.g., Washington’s three rounds of Economic Impact Payments). Meanwhile, most Americans were able to continue working and earning income amid a myriad of restrictions on the ability to spend. The net result was the accumulation of a massive amount of excess savings (Chart 2). By our reckoning, when the personal saving rate shot above its historical median of 8.4%, consumers were accumulating excess savings (note that in the months before the pandemic, the saving rate ran in the 6%-to-7% range). Over 1½ years beginning March 2020, $1.9 trillion was amassed. Then, as the saving rate slipped below this mark beginning in the autumn of 2021 (when the inflation alarm bells first sounded), excess savings started being drawn down. By the end of 2023, the excess was exhausted. Consumers began dipping into ‘regular’ savings to start 2024 with the saving rate now hovering historically low at less than 4%. There are other analyses of the ‘excess savings effect’ and, although they differ from our estimates with respect to timings and magnitudes, they share common themes. First, the buildup was large with little left now, if at all. Second, if there are lingering excess savings, they are skewed to higher income households (with less importance for spending). We reckon consumers should grow increasingly leery of dipping into regular savings the same way they did for excess savings, pointing to less of an offset for stubborn inflation and elevated interest rates—and more of a hit from them on consumer spending growth. However, this doesn’t dull spending prospects too much, with the household sector’s net worth topping a record $160 trillion in 2024Q1 (Chart 3). At 7.8 times disposable personal income, this is also a record apart from the pandemic years, again, when income was being whipsawed. Helping boost net wealth, the major equity market indices have lately been hitting record highs (Chart 4). And, more beneficial for a broader spectrum of consumers, home prices are back on the rise with home equity in tow (Chart 5). Net worth has grown by almost $13 trillion in the past year. Depending on the asset class, the ‘wealth effect’ (the impact of wealth gains on consumer spending) is estimated to run in the 2%-to-5% range, which puts the potential lift for consumer spending in the $250 billion-to-$650 billion range (which is 1.3%-to-3.4% of nominal outlays). This partly explains why the saving rate has recently been ratcheting lower. And not to be forgotten, job and wage growth are continuing to drive decent growth in total wages and salaries (employees’ incomes) (Chart 6). For example, the three-month trend for payroll employment expansion has been running in the 240,000-to-270,000 range since the start of the year (through May) with the yearly growth in average hourly earnings slowing but still hovering close to 4%. In total, wages and salaries are up 4.9% y/y in the latest month or a respectable 2.2% after adjusting for (PCEPI) inflation. The latter is in line with the median over the past couple of decades. Decent indeed. Bottom Line: One of the major supports for past consumer spending, excess savings being drawn down, has faded. This suggests high inflation and interest rates could weigh more heavily until there’s further relief on both fronts. In the meantime, a hefty wealth effect along with still-decent gains in jobs and wages should keep real consumer spending well-propped in positive territory. |
