There is a signal that has predicted most previous recessions: tens and twos invert. Demand rises for the two year and declines for the 10 year. Normally, the longer I keep your money, the more I have to pay in interest. The two year should always be lower than the 10 year since the government (in the form of bonds) will have your money longer on a 10 year.
Sometimes the short-term forecast might look better than the long term; for example, when people think there might be a recession in the next 18 months. That’s when you see people buying in on the two year and the rate drop on a 10 year because no one wants it.
Inflation: Yes, inflation is (really) bad. It hit 8.5% on the Consumer Price Index (CPI), the highest we have seen it in 40 years. That is the easy headline, but also the accurate one. When you peel back the onion though, you realize a majority of the inflation woes anchor in two locations: food and gas. We had the smallest increase in six months, if you take out inflation on food and gas. Some of this inflation is legitimate and real, while some percentage is supply chain issues and the war in Ukraine.
Interest Rates: The Fed is going ultra aggressive on raising rates. They are starting to feel like maybe they let the free money party go too far for too long. Now you’ve got Wall Street passed out drunk on the lawn after the free money bender. They’re nervous about inflation and they’re nervous about recession (see tens and twos above) so they need to slow down the economy to slow inflation. They also have the ability to lower rates if we enter into a steep recession.
Rates will continue to rise, and until we hit a recession, that will make the mortgage interest rates rise, causing a buy side headwind. When we enter into a recession, then the Fed will start cutting rates again to stimulate the economy.
Supply Side: We do indeed still have a supply side problem in residential real estate. Today, there are simply not enough homes for the people who want to buy them. This is the biggest contributing factor to the rapid appreciation over the last several years.
Per Freddie Mac, we’re short 3.8 million homes and it is even more exacerbated at the entry level. The new construction starts are up steeply and you can see the builders, big and small, trying to speed up to catch up. The problem is the finish rate is flat. Starts are way up but finishes are flat. Mostly because of a labor shortage and supply chain issues that will persist as China goes back into lockdown.
They’re trying but we will continue to have a huge shortfall near term in available housing. This insulates real estate prices somewhat should we head into a recession.
Recession: We have a frothy stock market and I personally believe we will see a recession in the next 18 months. I think it will be in early 2023 and it will start on Wall Street. It remains to be seen how hard that will spill over to Main Street.
Remember, a recession is simply two consecutive quarters of negative GDP. Most people don’t remember the recession of 2001 from March to November of that year because we only lost 0.3% of our GDP. But we all remember the recession of 2007-2009 since we lost 5.1% of our GDP. I think this recession will be more than 2001 and a lot less than 2007. If I were forced to forecast, I would say we’ll have somewhere around 1-1.5% decline in GDP which was like the recession of the early 90s. Pending consumer confidence reaction to heading into a recession.
Near Term: Consumer confidence is the key. We have a confidence-based economy and the steepness of the recession will be highly coralitive to the downward pressure on consumer confidence. My belief is that this recession will be somewhat mild, not nearly as bad for real estate, unless it is prolonged. Then there could be spillover from Wall Street to Main Street and real estate.
Medium/Long Term: What I am most focused on is 7-10 years out. That will be when we’ve chewed through most of the thick middle of the Millennial first-time home buyers. I think we’ll have some correction in inventory by then (Boomer dying, new homes catching up, etc.) and household formation is up, deaths will be up (Boomers), imigration steeply declining, etc. We could have an inventory surplus at exactly the time we don’t need it for much of the country. Of course, markets where there has always been a supply side problem (San Francisco Bay Area, Los Angles, or NYC) will feel this less.
While I’m basing the above predictions on various reports, emerging trends, and market conditions, I’ll be first to tell you that I didn’t have “global pandemic” in my 2020 predictions blog. Yes, this is where I see things going over the remainder of the year but we’ll keep monitoring and adjusting accordingly. Keep coming back each month for the latest econmic update.