The June CPI report showed that U.S. inflation rose at an annualized rate of 9.1 percent, a fresh COVID-19 pandemic high. The reading was worse than expected and prices continue to rise despite the Federal Reserve’s aggressive tightening. Inflation impacts most sectors of the economy, including the housing market, which was otherwise quite strong over the last two years.
Meanwhile, U.S. housing markets have shown signs of stagnation and some economists are predicting a crash in the housing market. Recession fears are also adding to the turmoil in the housing market.
Real assets tend to do well during periods of high inflation.
Real assets, which include real estate, commodities, and gold, tend to do well during periods of high inflation as investors seek solace in them. Growth stocks are usually impacted negatively during inflation, and so are companies with less or no pricing power.
How does inflation affect the housing market?
Inflation has a multi-faced impact on the housing market. First, during inflationary times, the cost of building a home goes up. Looking at the current market dynamics, the cost of building a house has increased significantly over the last 18 months as prices of everything from land, labor, lumber, steel, and cement have spiked.
Higher inflation also invariably leads to higher home prices. The relationship would hold as long as inflation is within reasonable limits. However, when inflation rises at a rapid pace, as is the case currently, inflation tends to have a negative impact on home prices.
Rising interest rates lower home affordability.
Home affordability in the U.S. is already running at multi-year lows. This means that it's costly to buy a house for the average buyer. While wages have also increased, home prices have risen even sharper.
Mortgage rates are rising and buyers are holding back on purchases.
With inflation running red hot, the U.S. Federal Reserve has raised rates by 150 basis points so far in 2022 and the stage looks set for another 75 basis points at the July meeting. Mortgage rates, which dipped to their all-time lows in 2021, have now climbed to multi-year highs. The combination of high home prices and higher mortgage rates doesn't bode well for home buyers.
Typically, buyers hold back on home purchases when mortgage rates are rising. This lowers the demand for housing and prices tend to fall. Incidentally, a lot of people have been canceling their deals to buy homes amid the rising mortgage rates and fears of a housing market crash.
So far, rising mortgage rates haven't had much impact on home prices even as the market has started to transition from a sellers’ market to a buyers’ market. Due to the rising cost of building homes, prices haven't crashed as many have been anticipating.
Not many see a housing market crash.
While some people believe that a housing market crash is on the horizon, not many agree. Despite rising inflation and a slowing economy, the U.S. job market has held off pretty well. A strong employment market supports home prices.
While it might sound counterintuitive, the housing market doesn't necessarily crash in a recession. While U.S. home prices plunged during the 2008-2009 recession, there have been instances when home prices actually rose during recessions.