- The Fed could trigger the next U.S. housing market crash.
- UBS predicts three rate cuts this year.
- Further rate cuts could encourage unnecessary risk-taking.
The U.S. housing market apparently enjoyed a terrific time in 2019 as home prices rose due to tight supply. But investors shouldn’t ignore the anomalies that are casting a dark shadow over the market.
It was surprising to see homes spend more days on the market even though supplies remained tight. Sales of both new and existing homes showed weakness at times last year despite the Federal Reserve’s best efforts to keep the housing market in good shape. The Fed is expected to adopt a similar approach in 2020, with UBS predicting three rate cuts may be on the way.
That’s a juicy prospect for housing market bulls, as the continuation of a low-rate stimulus is likely to boost home sales. Unfortunately, rock-bottom interest rates may eventually pave the way for the next housing market crash.
The U.S. housing market was handicapped despite rate cuts
Zillow estimates that the U.S. housing market was worth $33.3 trillion in 2018, up 6.2% on the year and 49% since 2012. But home value growth fell close to six-year lows in 2019, with Zillow projecting a much smaller increase of 3.8%. Assuming that U.S. home values increased an optimistic 4% in 2019, the overall market would have been worth close to $35 trillion.
But what’s surprising is that the U.S. housing market lost steam last year. There were favorable factors that should have led to a much stronger increase in home prices.
First, there was a major crunch on the supply front last year. In December, the inventory of homes for sale fell 12%, the largest decline in three years. The median price of a home increased 3% thanks to the weak supply. This increase in prices – thanks to low supply – is pricing buyers out of the market. This is evident from the larger-than-anticipated decline in existing homes sales in November.
The second reason why the housing market should have witnessed stronger price growth was the Fed’s multiple rate cuts. A low interest rate environment created by the Fed sent the 30-year fixed-rate mortgage to historic lows, leading to a sharp increase in mortgage applications.
The bottom line is that the rate cuts were not enough to give a nice boost to home values last year despite a supply crunch. If the Fed decides cuts rates further in 2020, it could trigger a major market downturn.
The Fed could light the fuse
Dallas Fed President Robert Kaplan recently admitted that the low interest rate environment has encouraged investors to buy risky assets. Kaplan told Bloomberg Television in an interview (as reported by MarketWatch):
Asked, in an interview on Bloomberg Television, if he worries that Fed policy decisions have given investors “a green light,” Kaplan replied: “Yes, I do.”
Kaplan added that investors might be thinking that the Fed has set a high bar for future rate hikes. In effect, they probably believe that low interest rates will continue and the UBS report adds to that belief. But the problem is that even a favorable interest rate environment may not save the U.S. housing market.
Low mortgage rates could encourage those who are not capable of affording a home to jump into the market. And once such consumers take the plunge, things could start going south.
Weak price growth will be the market’s undoing
The weakness in home price growth is likely to continue in 2020 as sales could decline by 1.8%. That’s alarming because lower home sales in a tight supply environment could force sellers to reduce prices. Zillow data suggest that the median listing price per square feet is already on the decline.
A combination of weak wage growth and emerging cracks in the job market could force potential buyers to think twice before purchasing a home. And as demand falls, prices are likely to follow suit. Once that starts happening, homeowners could be left with negative equity. Those who didn’t have enough money to put up a substantial down payment could be left in the lurch if the economy takes a turn for the worse and jobs disappear.
ATTOM Data Solutions reported in November that more than 25 percent of all properties were “seriously underwater” across 160 zip codes in the U.S. When prices decline and owners of properties with negative equity start feeling the pinch, foreclosures will spike. Inventories will rise in that case and crush home prices further.
So, the Fed could do the U.S. housing market a big disservice by reducing interest rates further. All this will do is encourage unnecessary risk-taking.
Disclaimer: The opinions in this article do not necessarily reflect the views of CCN.com.