• Home prices continue to climb in the US despite a downshift in activity in the housing market.
  • But price declines will come in 2023, according to Desmond Lachman of AEI.
  • Lachman is a former deputy director at the International Monetary Fund.

Could inflation finally be at — or very near — its peak? In recent months, inflation has climbed to the highest rate it’s been at in decades. 

However, one economist says that we may have seen the worst. According to Desmond Lachman, senior fellow at the American Enterprise Institute and a former deputy director at the International Monetary Fund, inflation will have dropped to levels closer to 7.5% in the next two months given falling gas prices and a stronger dollar.

Some might view that as a positive sign for a cooling housing market. With inflation coming down, the Federal Reserve might be able to back off of its uber-hawkish stance sooner than expected, and mortgage rates could be set to drop from their near 6% levels. 

But as Lachman thinks the proverbial die has already been cast for the fate of the housing market.

“In terms of housing prices, the damage is likely to have already been done,” Lachman said on Tuesday, citing three reasons. 

One reason is inflation has continued to soar over the last few months to a 41-year-high of 9.1% has forced the Fed to hike rates aggressively, and will ensure they will continue to hike at their coming meetings, Lachman said. The central bank, which last year walked back their vew that inflation would be transitory, has also started shrinking their balance sheet by not buying new Treasury bonds and mortgage-backed securities. This move creates upward pressure on mortgage rates. 

“They’re going to keep monetary policy tight, even if inflation peaks,” he said. “They’re likely to keep the breaks on because they don’t want to screw up on inflation again.”

The continued hawkish stance will keep mortgage rates up, Lachman said. Mortgage rates have skyrocketed since the start of the year, with 30-year fixed rates near 6%. This has slashed demand for homes significantly in recent months, and will be the biggest factor in bringing home prices down, he said.

In June, existing home sales were down more than 14% year-over-year and 5.4% from May. Homebuilder sentiment is also at its lowest level in 37 years save for April 2020, when the US was still in the early stages of the COVID-19 pandemic. This is being reflected in the falling number of homes being built.

Another reason home prices are likely to fall is because the Fed’s tightening and forward guidance thus far is likely to push the US economy into recession, Lachman said. Job losses that occur during a recession will also weigh on housing demand, he said.

“If the economy goes into recession because the Fed has been too tight, housing would go down because people don’t have jobs, and when they don’t have jobs, they don’t buy houses,” he said. 

And third, declines in the stock market — the S&P 500 is down 18% year-to-date — will also hurt demand as wealth gets destroyed, Lachman said. He believes the losses for equities will continue in the months ahead with corporate earnings being at risk of downward revisions.

Walmart, for example, said on Monday afternoon that they expect -11-13% profit growth in 2022 compared to the -1% they had originally expected. The stock is down more than 7% since the announcement.

“I think that that’s the first of many,” Lachman said of Walmart’s downward revision. 

But the price declines in the housing market won’t happen immediately, Lachman thinks. This is because sellers will be in denial at first, but once they see their home sitting on the market for an extended time, they will be forced to lower prices. 

Lachman sees home prices falling 15-20% in 2023 before eventually beginning to recover toward the end of 2023, when he thinks the Fed could start easing. 

Lachman isn’t the only one bearish on the housing market. Ian Shepherdson, the founder of Pantheon Macroeconomics who warned of the mid-2000s housing crisis, has said he expects to see modest home price declines due to falling demand. 

Shepherdson also said in a note to clients on Tuesday that the Fed will likely have to remain hawkish until it’s clear inflation is coming down.

“The Fed is boxed-in to a 75bp hike today, and the latest inflation data likely will keep the talk hawkish,” he said. “Things will change by September, but Chair Powell can’t claim victory yet, after the ‘transitory’ debacle.”

Shepherdson added: “We doubt Mr. Powell will be drawn into making any predictions of a slower pace of tightening as soon as the next meeting.”

José Torres, a senior economist at Interactive Brokers, also told Insider last week that he expects a drop in home prices similar to that seen during the Great Financial Crisis in the mid-2000s. 

Michael Cook, an investment analyst at Penn Mutual Asset Management, also said last week that he believes home prices would start to revert back toward pre-pandemic levels.

Goldman Sachs researchers also said in June that they expect a decline of 3% in US home prices ahead. 

And on Tuesday, National Association of Homebuilders CEO Jerry Howard told Bloomberg last week that “we’re heading into a housing recession.”

Still, some don’t see price declines ahead. Morgan Stanley, for example, said last week that a lack of adequate supply should prop up prices despite tightening conditions. This has been a common argument among those saying home price declines are not in store. Median prices of homes sold continue to climb in spite of the slowing activity, hitting $428,006 in June, according to Redfin data. That’s up 11% year-over-year. 

To Lachman, however, tight supply dynamics will change with demand is receding as much as it is. 

This is already showing up in housing supply data. Months supply of new homes is now at 9.3 months, the highest level since 2010, according to Census Bureau data. 

months supply of new homes

Federal Reserve Bank of St. Louis

“Right now there is a shortage of supply, but my point is if demand is falling off a cliff, it doesn’t matter that there’s a shortage of supply,” Lachman said. “If the demand falls enough, you’re then going to have those inventories going up and the price coming down.”

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