Analysis of the Housing Market and Monetary Policy Impact

Rising rents and mortgage payments have been at the center of the inflation discussion. Our Global Chief Economist assesses whether monetary policy can effectively blunt those figures. 

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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. Along with my colleagues bringing you a variety of perspectives, today I'll be talking about the housing market, inflation, growth and monetary policy. 

It's Monday, July 1st, at 11am in New York. 

Housing is at the center of many macro debates from growth to inflation. And when you put those two together – monetary policy. House prices have continued to rise despite high interest rates, which gives the impression to some of stalled deflation and forces consumers at times to make some really difficult choices. And in some economies, there's a seeming lack of responsiveness of housing to higher interest rates. All of which tends to prompt questions about the efficacy of monetary policy. 

So where are we? We think monetary policy is still working through housing as it usually does, but supply shortages, or in some places just idiosyncratic factors like buildable lands or permitting, that's supported home prices. And as has been the case across several sectors in this business cycle, there really are some factors about housing that's just different in this cycle than in previous ones. For the U.S., a key part of the housing story has been the mortgage lock in for homeowners. Our strategists have noted that the gap between the current new mortgage rate and the average effective mortgage rate is at historical highs. And the share of 30 year fixed rate mortgages is at its highest in a decade. 

Consequently, the inventory of existing houses has remained low because homeowners who have those really low mortgages are reluctant to move unless they have to. The market has become thinner with less available supply; and then if we think more broadly for the economy, there's a risk of labor market frictions if that mortgage lock in also reduces labor mobility. 

Now, there will be a decline in mortgage rates if we get the modest easing cycle from the Fed that we expect. But that decline will be similarly modest so that gap in rates will not be fully closed even if it narrows. And so there might be some uplift to supply of housing, but it might not be huge. That decline in mortgage rates can also supply demand, so then we have to think about the net of this shift in demand and the shift in supply. And ultimately what we think is going to happen is that there'll be a moderation in home price appreciation, but not an outright decline in home prices.

First, the choice of housing for a lot of households is do you buy or do you rent? If you've got high home prices and high mortgages, buying is much less affordable and so it pushes people into renting, which could push up rents. That phenomenon is partly responsible for the surge in rents that we've seen over the past few years. 

In the longer run, there should be a sort of arbitrage condition between home prices and rents. And while rising home prices can impinge the spending power for first time homebuyers, rising house prices can actually boost sentiment and consumption for existing homeowners. 

And that mortgage lock in that I talked about before? Well, that can actually support aggregate consumption to some degree because now there's predictability of cash flows and the monthly payment is pretty low. 

So what do we do when we take all of this together? The housing market might be telling us that monetary policy is working a bit less effectively than historically, but not that monetary policy is not working. 

Home price appreciation is moderating. Housing starts have slowed, as usual, following those big rate increases. But that slowing? It's actually been a bit inconsistent because mortgage lock has meant that new supply is the only supply. Existing home sales, by contrast, are just plain weak. They're about as weak as they were around the financial crisis. 

We do not think the housing market overall is at risk of collapse, but monetary policy is restraining activity in a very familiar way. 

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