According to Kushi, since the beginning of the before pandemic, the housing market has experienced a series of highs and lows, but the pandemic environment reshaped the role of a home, pushing demand to new highs, and price appreciation among the highest of all time.
However, recent raises in the nominal interest rate and the Federal Reserve’s monetary policy tightening constrained the housing market during the second half of 2022 as both buyers and sellers fled the market.
So Kushi poses the question: “will the recent housing freeze continue into 2023, or will thawing begin?”
Kushi begins her answer by saying there are three scenarios for the 2023 housing market but is largely dependent on the path of inflation and future monetary tightening.
The most likely situation is that the Federal Reserve focuses on the dynamics of the inflation in parts, which at the present time is falling. Core services seems to be the last struggling component of the economy. Employers are still searching for labor, pushing wages higher while the Fed is expected to continue rate hikes until interest rates hits a rate of 5-5.25%.
These factors will all influence and put pressure on treasury bonds, and therefore, mortgage rates in the first half of the year.
“Higher mortgage rates negatively impact both housing demand and supply, pricing out buyers who lose purchasing power and keeping some potential sellers rate-locked in,” Kushi said. Prices will also continue to correct and reflect the new dynamic of less demand relative to slightly more, yet still well below historically normal, levels of supply. If inflation responds as expected in 2023 and the Fed’s terminal rate target is right, mortgage rates may start to decline as inflation expectations ease. Lower house prices and modestly lower mortgage rates would give house-buying power a boost.”
A bad scenario reflects an economy that see inflation stagnate, if not rise—this will put even more monetary pressure on the market and push up mortgage rates even further. This could freeze the market by keeping homes off the market and sidelining what buyers are left.
A better situation would be a scenario where no further interest rate hikes take place because inflation comes down more than expected.
“This scenario assumes consumers choose to pull back on spending, despite still sitting on a lot of excess savings built up during the pandemic. As a result, mortgage rates may stabilize sooner than in the base case, and potential buyers and sellers would benefit from the lack of rate volatility,” Kushi said. “Prices would continue to adjust in response to higher rates, which may provide an affordability boost to potential home buyers. But, even in this scenario, the housing market will still struggle from a lack of supply. Potential sellers would still be locked into record-low mortgage rates and hesitant to sell in a higher interest-rate environment.”
“In all three cases, the housing market will continue to rebalance as prices adjust to the reality of higher mortgage rates,” Kushi concluded. “However, the pace of price deceleration and the decline in home sales will be more severe in the downside, higher inflation scenario.”
“The main trend to watch is whether mortgage rates will go any higher and, if so, by how much. Once mortgage rates peak, home sales volume and price declines will stabilize. That all depends on what the Fed chooses to do in the coming months and whether inflation begins to decline.