The Drag From Higher Mortgage Rates
Mortgage rates have increased more than 1 percentage point since early May, jumping half a percentage point since last week’s FOMC meeting, raising concerns that this rapid rise may derail the housing recovery and dim the outlook for the broader economy, especially in the context of generally tighter financial conditions. As Goldman notes, the rise in mortgage rates may impact the economy through two broad channels: (1) the direct impact on construction activity and home sales, which feed into the residential investment component of GDP, and (2) the indirect effects of lower home prices and less refinancing activity on consumption. Goldman estimates Housing Starts could plunge 11% in the coming quarters, total home sales could drop 7%, residential investment may fall 6 percentage points, could weigh on home prices, and pull up to 0.4 percentage points from real GDP growth - presenting a significant downside risk to their somewhat rosy current outlook.
Via Goldman Sachs,
Mortgage rates have increased more than 1 percentage point since early May, jumping half a percentage point since last week’s hawkish FOMC surprise. The latest weekly data, released this Thursday, show the Freddie Mac 30-year fixed rate benchmark standing at 4.46% (Exhibit 1). Many have raised concerns that the rapid rise in mortgage rates may derail the housing recovery?which has been a welcome bright spot in the economy in recent quarters?by reducing housing affordability, and could potentially dim the outlook for the US macroeconomy more broadly. For a mortgage on a median-priced single family home (around $200,000) with a 20% down payment, the recent rise in rates represents roughly an increase of $100 in the monthly mortgage payment, or about 2½% of pre-tax median household income.
Based on their general VAR-based approach, the chart below shows the estimated impact of a 1 percentage point increase in mortgage rates on housing starts. Starts fall by about 11% over 4 quarters, which is consistent with our prior work estimating a 150k impact on housing starts per percentage point increase in rates...
Residential investment in the GDP accounts includes three main subcategories: structures (which are closely related to housing starts with a lag), improvements (such as refinishing kitchens, installing wood floors, etc.), and the relatively small category of brokers’ commissions (related to new and existing home sales). Our past work has suggested that a 1 percentage point increase in mortgage rates might reduce total home sales by 7%, and our VAR results generally agree with this magnitude.
Looking at the impulse response for residential investment as a whole in Exhibit 2, we see that the maximum level impact occurs several quarters after the maximum impact on housing starts. Over the next year, the VAR predicts that residential investment might decline by six percentage points relative to a baseline.
Putting the pieces together, we would expect a growth drag from the direct and indirect effects of higher mortgage rates of around 2 tenths of a percentage point over the next year, although of course there is significant uncertainty around this estimate.
Importantly, the recent increase in mortgage rates has been only one part of a broader tightening in financial conditions including a stronger dollar and lower stock prices - that might be expected to subtract around 0.4 percentage point from real GDP growth over the next year (Exhibit 5).
The bottom-line - This represents an appreciable but not insurmountable growth drag... and a continued deterioration in financial conditions would present a significant downside risk to that outlook.