NAHB housing market index signals pessimism in August

Summary

Home Builders See Conditions Continuing to Weaken

The National Association of Home Builders/Wells Fargo Housing Market Index (HMI) fell six points in August to 49. This past month's drop marks the eighth consecutive decline for the HMI and marks the first time since May 2020 that this closely watched index has fallen below the key 50 breakeven level, which indicates that more home builders currently rate sales conditions as poor than those who rate conditions as good.

While the August HMI drop was considerably larger than consensus estimates, it hardly comes as a surprise. Builders have been reporting weaker buyer traffic since early this year, and a rising number of builders have reported a spike in cancelations. Many are responding by reducing prices or offering incentives to help offset the impact of higher mortgage rates.

All three components of the HMI fell in August, and all three are at their lowest levels since May 2020, which was just before housing activity rebounded following the pandemic lockdown. The present sales series fell seven points in August to 57, and the future sales series fell two points to 47. Prospective buyer traffic fell five points to 32.

The HMI has a strong correlation with home sales and is a reliable leading indicator of single-family housing starts. Nearly one of every five home builders surveyed reported reducing prices in August, which might help explain the ten-point gap between builders' perception of current versus future sales. There are limits on home builders' ability to cut prices to support sales, however. Many builders have a large number of homes under construction that are set to be completed once a buyer signs a contract. With buyer traffic slowing even more abruptly, we expect new home sales and single-family housing starts to slow considerably in the coming months. With all the discounting, new home prices should decline substantially.

Source: U.S. Department of Commerce, NAHB and Wells Fargo Economics

Housing Remains the Key Transmission Mechanism for Monetary Policy

• Higher interest rates have taken the air out of the pandemic housing boom. Buyer traffic has plummeted to its lowest level since the start of the pandemic, when almost everything was locked down. Aside from the pandemic, buyer traffic has not been this weak since April 2014.

• Home builders have responded to the drop in buyer traffic by slashing prices and offering incentives to help offset the impact of higher mortgage rates. The discounts and incentives are helping support sales in the near term, and builders had fairly high profit margins going into the slowdown. The ability to slash prices is limited, however, by higher construction costs. The Producer Price Index for home construction has risen nearly in lock step with new home prices over the past year, and higher short-term interest rates will add to the carrying cost of the large number of single-family homes builders currently have under construction.

• The drop in buyer traffic and expected new home sales should sharply reduce single-family starts in coming months, which should also help curb supply chain bottlenecks in the industry. Mortgage rates have also fallen from the highs hit earlier this year.

• The housing market remains the key transmission mechanism for the Federal Reserve. Home sales and new home construction were among the first industries to take off as the economy reopened in mid-2020. Housing has a powerful multiplier effect throughout the economy, driving demand for building materials, mortgages, insurance, furniture and a whole host of household services.

• The HMI fell in all four regions, tumbling eight points in the Northeast to 39 and falling seven points in the Midwest to 42. Home builders also noted a weakening in demand in the South (-6 points to 52) and West (-5 points to 42). The South is the only region where housing demand has held above the key 50 breakeven level. The region continues to benefit from an influx of buyers from other parts of the country, many of which sold homes in higher-priced markets and have considerable purchasing power in the relatively more affordable South.

Source: Federal Reserve Board, NAHB and Wells Fargo Economics

Source: NAHB and Wells Fargo Economics

Source: U.S. Department of Commerce, NAHB and Wells Fargo Economics

Source: NAHB and Wells Fargo Economics