The Liquidity Vacuum

HIGHLIGHTS:

• The Fed, and central banks globally, have been sucking liquidity out of the financial system via rate hikes and balance sheet maneuvers.
• Residential home prices have fallen for seven consecutive months, down about 5 percent from their most recent peak in June 2022.
• Mortgage rates—the largest determinant in housing buying power—have climbed notably over the last year but declined in recent weeks.
• Borrowing cost declines take longer to work themselves into the market, which may not be factored into current prices.

The dramatic increase in interest rates over the last year continues to work its way through the global economic engine. The US Federal Reserve has led the parade of global central banks in sucking liquidity out of the system through various rate hikes and balance sheet maneuvers. While these Scrooge-like endeavors often produce a lagging effect, one metric in particular––residential home prices—has been quick to react, and continues to bear the weight of the decrease in liquidity.

Residential home prices, as measured by the S&P CoreLogic Case-Shiller National Home Price Index fell for the seventh straight month. The roughly half-percent decline in median home prices in January confirms a trend that began last July as higher interest rates seeped into the mortgage market. Mortgage rates are the largest single determinant of housing purchasing power. While year-over-year home-price growth continues to be positive at 3.8 percent, the monthly trend of declining prices has been established. Overall, home prices have fallen 5.1 percent since their most recent peak in June 2022.

The historic quid pro quo relationship between interest rate hikes and housing price declines is well documented. The Federal Reserve Bank of San Francisco recently published a study that found interest rate increases only take about two weeks to show up in the price of homes around the country. However, this study noted that "long-term" rates were the number that moved housing prices—not the fed funds rate.

What does this mean for the future of housing prices? Despite the Fed's recent rate hikes, and the potential for a few more, 30-year fixed rates have declined in recent weeks. The average 30-year FHA mortgage rate in October peaked near 7 percent and currently stands at 6.4 percent. The mostly commonly used benchmark for rates, the 10-Year US Treasury yield, just this month has also seen a noticeable decline. Mortgage rate declines take a bit longer to work into the housing market than increases. Therefore, we can assume this tailwind is perhaps not fully factored into prices.

While other inputs affect housing prices—including employment trends and economic sentiment—the largest single influence has become slightly more palatable in recent weeks. All else being equal, this could be a positive indicator for future housing price trends. Alas, the assumption of all else being equal in the current world is a tricky bet.

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