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The Federal Reserve’s actions at its July meeting will be an important tell for both the housing market and the overall economy due to the interconnectivity between the three.

After 10 short-term rate increases since March 2022, the Federal Reserve took no further rate action at its most recent meeting. While the Federal Reserve could pause on rate increases again in its July meeting, it is likely it will raise rates again, according to Zonda chief economist Ali Wolf.

“The key thing we know is that the labor market has yet to post a notable cooldown across the economy. We’ve had six job reports so far this year with an average of nearly 300,000 jobs added. We have a 3.6% unemployment rate,” Wolf said during Zonda’s most recent Housing Market Update Webinar, explaining how the Federal Reserve could interpret recent data. “When you look at some of the layoffs that have happened in the economy, what we also know is that those that become unemployed are often able to find another job quite quickly—we’re still seeing this resilience.”

In addition to the strength of the employment market, real wage growth has gone positive for the first time since prior to the pandemic, indicating wages are growing at a faster pace than inflation. The most recent Consumer Price Index (CPI) indicates headline inflation has come down to just 3%, a significant improvement from a year ago when inflation averaged around 9%. Additionally, the shelter index—which accounts for 43% of the overall CPI—is a lagging indicator. Wolf said it typically takes 12 months for a slowdown in shelter to show up in the CPI data.

“[This] is why most people feel quite confident that inflation is going to continue to move in the right direction,” Wolf said. “[However], if we see housing get too strong too quickly, that could put some of these improvements at risk.”

Wolf said because the labor market and inflation are both still running hot, albeit moving in the right direction, the Federal Reserve is likely to evaluate that a further short-term rate increase is necessary. During the webinar, Wolf outlined several scenarios of an eventual rate cut and the likely impact on mortgage rates in the housing market.

“When the Fed raises rates, it’s not a one for one that mortgage rates go up to the same extent. That same logic applies when the Fed starts cutting rates,” Wolf said. “You usually see mortgage rates have a six-month lead time. That’s really important because what we’re saying is maybe by the middle of next year we could already be seeing mortgage rates rolling over in advance of the Federal Reserve doing their cuts.”

New-Home Market Update

Despite interest rates between 6% and 7% in recent months, data indicates that consumers are still active in the new-home market, with Wolf saying total new-home sales are above 2019 levels. With many homeowners reluctant to give up low interest rates and sell their homes, the new-home market has continued to take market share from the existing-home segment. While the demand pool is smaller due to many consumers being priced out, high rates have had a significant impact on supply, meaning builders with inventory have been able to benefit from how the market has progressed.

“[Builders] have the ability to capture buyers that traditionally want to go in the resale market. Builders have a direct competitive product [to the resale market], and we’ve seen that product [quick move-ins] only grow compared to last year,” Wolf said.

Wolf said builders are also benefiting from improved supply chains that have shifted cycle times from 12 to 15 months during the worst of the pandemic period to four to seven months in the current market. Additionally, Zonda data indicates 40% of builders have more than half of their buyers using rate buydowns to improve attainability and affordability in the high rate environment.

More than 50% of builders are still increasing prices, but they are taking a more cautious approach in the current market, according to Zonda senior managing principal Tim Sullivan. Among builder respondents to a Zonda survey, new-home affordability and consumer confidence were two of the biggest worries for builders in the current market.

“Caution is definitely the word of the day. One of the basic reasons is affordability as a concern,” Sullivan said. “When we ask the builders [their] biggest hurdles related to demand, [they’re] saying mortgage rates, affordability, and home prices.”

In addition to affordability concerns, Sullivan said many builders are also expressing concern in regard to land prices. More than a third of builders said land prices are primarily moving higher compared with a few months ago. However, despite land price increases, 34% of builders are approaching land acquisition with a “full steam ahead” approach, which is significantly higher than as recently as December when fewer than 5% of builders were employing a “full steam ahead” approach.

The strength of the housing market has also caused a reversal in attitude toward housing starts among builders surveyed by Zonda. In November 2022, 75% of builders expressed plans to slow starts between 1% and more than 30% compared with 2022 levels. In June, only 32% of builders said they expect starts to be lower than 2022 levels this year. Conversely, 21% of builders said starts will likely be up more than 10% compared with 2022 levels.