7 December 2022: How far can the housing market fall?

One of the keys to the potential depth of the recession that may have already begun is the weakness of the housing market and how much average house prices will fall across the entire country.

Every sector of the economy feeds into the housing market; employment, productivity, output, manufacturing, import of goods and lending. It is a key barometer of the health, or otherwise, of the economy.

The latest data shows that although prices are continuing to rise, the size of the increase, reported monthly, is falling. Last month it fell from 8.6% to 7.4%.

That fall is likely to fall into negative territory as activity slows, and interest rates continue to rise. In normal circumstances, the Central Bank would be loosening monetary policy to encourage activity in the market. As interest rates fall, those considering moving house or even remortgaging the property they occupy presently, are more likely to enter the market.

In the current situation, the Bank of England is continuing to tighten monetary policy by hiking interest rates, this is usually done to flatten demand and slow activity, but with the economy failing, and inflation rising it is in a difficult situation.

In the last recession between 2010 and 2013, the prices fell by an average of 12% across the entire country. There was also a significant fall in activity. This spreads across the entire market, including both existing home sales and the construction of new builds.

The effect of a slowdown sees employment in the construction industry fall as less properties are built.

Often, building firms will halt construction or not begin new projects. In the current environment, the cost of carrying or holding the land is increasing as interest rates rise.

The construction element of the monthly PMI is slowing rapidly, although it is still in positive territory. In November, it fell from 53.2 to 50.4 just above the level which divides growth and contraction.

The level of growth and activity, in this sector, is a crucial consideration when the Bank of England meets to agree monetary policy. The fact that activity is now only just above the level when it is beginning to contract, will go some way to helping them to decide whether the economy can take another jumbo rate hike.

Sterling fell yesterday to a low of 1.2133 versus the dollar as a mixture of risk aversion and uncertainty about the FOMC’s next move drove activity. It closed at 1.2138.

The price of a barrel of oil fell to below $80 on the wholesale market despite the threat of Russia cutting production as it refuses to sell at the level of $60 which has been set by the EU.

Provided the price is still around this level, and doesn’t encourage OPEC to reduce production overall, it should see a general fall in inflation that will be most keenly felt in the U.S.

An average oil price of around $80 between now and next week’s FOMC meeting should guarantee a tapering of the next interest rate hike.

It is something of a chicken and egg situation in that is the U.S. economy slowing to such an extent that demand for oil is falling, or is overproduction leading to oversupply? Either way, the U.S. economy will benefit eventually from a reduction in the oil price.

However, given that the U.S. is a net exporter of oil, if the price falls too far it could lead to the mothballing of production which would see the oil and gas sector suffer as labour is laid off.

There are a considerable number of elite CEOs and CFOs lining up to supply their take on the economy to financial journalists currently.

There are high level factors which affect the economy currently and lead observers to feel that either a recession or a general slowdown is coming. A potential strike by railroad workers is one such event.

However, there are several industry specific issues that are continuing to contribute to the view that a slowdown cannot be avoided. An example of this is the shortage of semiconductors as the U.S. continues to ban their import from China.

The reduction of covid related restrictions in China should influence the level of activity between the two superpowers, but China is in no mood to provide a boost to the U.S. economy while the level of antipathy between the two nations remains raised.

While the Central Bank meetings are still a week away, the market has been concentrating on risk aversion given the uncertainty that exists about future monetary policy.

The dollar index rallied to a high of 105.63 yesterday in thin trade. It closed at 105.57. Trade is likely to slow down following the ECN and FOMC meetings next week as we begin the holiday season and liquidity falls.

Construction Sector PMIs for November showed that activity in the sector continues to fall. One of the main reasons for the lack of activity is still the war in Ukraine, which appears to have taken on an attritional state, with no new offensives from the Russian side and little offensive action from Ukrainian forces.

As winter draws on and the weather is more demanding, both sides are digging into defensive positions.

The fall in construction means that there are similar knock-ons being seen to those affecting the UK, only that in this situation, they are crossing national borders despite the free moment, and are on a far larger scale.

The upsurge in nuclear power generation, will see the effect of the fall in the wholesale price of oil have limited effect, but it should continue to contribute to the fall in headline inflation.

If the price of a barrel of oil remains below an average of $80for the next month or so, not only will it place pressure on next week’s meeting of the ECB’s General Council, but on the following meeting as well, and will encourage the doves to call for either a tapering of rates or a pivot from the Central Bank which would provide support for the weaker economies

The more hawkish nations, like Austria and Germany, will need to be convinced of the future path of inflation before that will sanction any move towards the return of accommodative rates.

Longer term, the goal of the Central Bank must be for rates to be in a neutral mode, with only minor tweaks needed to adjust for inflation. However, given that the Eurozone is prone to a five to seven-year cycle of emerging crises, that goal may be almost impossible to achieve, which will contribute to a boom/bust scenario

The euro is still driven by a possible divergence of monetary policy from the FOMC and ECB. Yesterday, the dollar was in the ascendancy, which saw the single currency weaken. It fell to a low of 1.0459 and closed at 1.0469.

Have a great day!