Summary: Geopolitical developments in Washington, London and Beijing have commanded a huge amount of attention is recent months and other fundamental indicators – most importantly, the US housing market – have been neglected. But US housing is a reliable harbinger of the overall economy and must not be ignored.
Excluding housing, I suppose President Trump is completely right: the US economy in in perfect shape. The problem is that housing is a key driver of US growth and the current slowdown should be considered by investors and the Fed as a very worrying omen for 2019, mostly for three reasons:
-US real estate market prices are hot again. The Case-Shiller national index has almost reached its pre-crisis level. New boom cities have appeared to replace Miami and Las Vegas. In some US cities, prices are up to 50% higher than their previous pre-Global Financial Crisis peak.
-The real estate slowdown is worrying considering that it is happening while consumer confidence is at its highest point. The main issue seems to be about affordability and the fear of higher interest rates.
-This is a bearish sign for the US economy since the real estate sector tends to be a leading indicator of the business cycle. It will have significant implications on the Fed's monetary policy in 2019 as real estate might replace the labour market as the main focus.
The US real estate market has fully recovered from the crisis
The Case-Shiller national index has almost reached its pre-GFC level. New boom cities have emerged to replace Miami and Las Vegas where housing prices are below their 2007 levels. In Boston, prices are 33% higher than their previous peak; Seattle and Dallas around 60% higher (chart 1).
However, contrary to 2007, household indebtedness is more sustainable since the ratio of household debt to net disposable income is around 109% versus 142% in 2007.
The current slowdown is happening while consumer confidence is skyrocketing
There has been more and more evidence over the past few months of a slowdown in the housing market. The latest data confirm a US homebuilder’s sentiment drop to 60 points, its lowest level since summer 2016. Housing starts have notably slowed since last January, but the bulk of the weakness has mostly come from the multi-family space (chart 2).
In addition, existing home sales are experiencing their sixth consecutive month of decline. Over the last 20 years, this has occurred just three times: in 1999 (before the bursting of the internet bubble), in 2007 (during the housing crisis), and in 2013 (chart 3).
This steady decline is rather surprising considering that it's happening while consumer confidence is at its highest point.
The degraded conditions for buying houses are explained by affordability or the lack of thereof:
-21% of US households mention high prices as a reason for not buying houses, the highest level since the end of 2006 (chart 4)
-75% of households see higher interest rates in the next year, the highest level since early 2007 (chart 5)
-A mere 4% expect rates will go down (chart 6)
The real estate market slowdown is a strong bearish signal on the US economy
The US housing market is often a good leading indicator of the US economy:
-CME lumber, which is a good barometer of the construction sector and, also, a leading indicator of the US economy, has sharply fallen since last spring (chart 7)
-Residential investment, which has consistently and significantly contributed to weakness before the recessions, has marked its third straight quarterly decline since late 2008/early 2009 (chart 8)
Conclusion: The US housing market has peaked and its slowdown points to lower US growth
So far, the market has paid very little attention to the acceleration of the slowdown in housing since investors have been too busy scrutinising the latest geopolitical developments on both sides of the Atlantic. This is, however, a major evolution which constitutes another signal that the US is at the end of the business cycle and that we should expect lower growth in 2019.
This slowdown will have deep implications on the Fed monetary policy as higher rates pose the risk of putting housing into a recession. Home buyers are not used to such high mortgage rate – now close to 5% (chart 9). If this negative trend continues, it will weight on the Fed's hiking path and push for a more dovish tone after a December hike.
While a deep recession may not be iminent thanks to central bank policy, interest rates will have to stay high for longer, and this will be accompanied by volatility risk from the unwinding of bubbles, especially within AI.
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The USD is on its back foot as markets celebrate an eventual Fed rate peak and steady long US yields. The stakes are even higher for the Japanese yen if longer major sovereign yield curves have to price in economic acceleration.
While commodities, broadly speaking, have faced some tough months, a partial reversal during June could signal that the asset class is getting back on its feet with energy holding up and precious metals with upside potential.
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As inflation remains high central banks face hard decisions about whether they should keep hiking interest rates or stop. Meanwhile, the rise of AI creates bubble-like conditions that only make the decision harder.
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