Premier Miton Macro Thematic Multi Asset Team
Housing plays a key part in the US and UK economies. Homes are a key asset for most households, housing transactions drive many other consumer decisions, such as durables purchases, housing wealth leads to confidence to spend, and new home building is a key driver of employment trends.
For these reasons housing cycles tend to coincide with economic cycles, when housing turns down so does overall economic activity and vice versa. An obvious example would be the Global Financial Crisis and the collapse of a housing bubble that precipitated it. On a smaller scale, most recent economic cycles in the US have coincided with housing cycles.
A major driver of the housing cycle has been the availability and affordability of credit. The marginal buyer of housing is always a leveraged, typically first-time buyer, and these form the basis of transactions further up the chain.
These buyers have experienced, or are about to experience, a major shock as mortgage costs are set to soar. In the US, buyers typically take a 30-year fixed rate, penalty free mortgage, which they can refinance as rates fall but take a new mortgage if they move house. The chart on the left below shows the progression of these rates over the course of this year.
Source Bloomberg: 04.10.21 – 30.09.22.
In the UK a 3- or 5-year fixed rate mortgage is more normal and the cost of this is based off the ‘swap rate’ as shown above on the right, again a dramatic rise.
Affordability has slumped such that many first-time buyers will either have to delay purchases or will be forced to constrain their spending more generally. Similarly, those trading up will have their budget massively constrained.
The reason this is particularly important is that stock market bear phases rarely bottom out until the housing market bottoms, which tends to mark the low for the economy. Yet this year housing has remained reasonably strong despite rising interest rates. However, the pace of recent rises has taken rates for new mortgages to levels not seen for 10 to 20 years. We could potentially be facing a major correction in housing volumes and prices. A slowdown in housing would feed through to many other parts of the economy, not least employment but also consumer spending, raw materials and so on.
Arguably the US Federal Reverse desires a housing slowdown as it needs a weaker employment market for inflation to ease. With the US effectively at full employment inflation is becoming endemic. The mechanism for interest rate rises to feed through to the inflation for the US and the UK is on consumption via the higher housing costs.
We think the risks remain to the downside, thus far we have seen equities reprice for higher interest rates, but earnings forecasts haven’t yet reflected a weaker economy while consumption and employment remain strong. It appears to us that this phase may be ahead of us. Hence, we still remain cautious within our equity and fixed income exposure.