Based on recent data, the Federal Reserve is only a few months away from raising rates for the first time since July 2007. But the US housing sector, though improving, remains distinctively subdued and any recent momentum could be whisked away as the Fed embraces policy normalisation.
The plight of the US property market in the years leading up to and after the financial crisis is well-worn turf. Nevertheless, the persistence of this episode remains striking and no more so now that the Fed is ready to take the next step on the path to normality.
Of the many opportunities and threats facing the US economy, few are as unquantifiable as that of its property sector. The market could quite conceivably boom or bust in the next three years and it wouldn’t necessarily be surprising.
The market has been in a rut for the past seven years -- following a boom that was financed by excessive risk-taking and an unhealthy dose of hubris -- with low interest rates largely failing to create a lasting recovery.
With rates set to rise, there is obviously a risk that whatever progress has been made could stall. The counterview is that the market has been weak for so long that what was once a supply overhang may now have transformed into a housing shortage.
Using trend figures, housing starts, for example, have doubled from their trough but remain around 50 per cent below their November 2005 peak. To put this in perspective, housing starts -- and therefore residential construction -- continue to hover around levels that were considered normal at the beginning of the Clinton administration.
This isn't sustainable over the long term and creates an obvious upside risk for the US economy. The key question is whether a few rate hikes could delay investment significantly. The reality though is that people need housing and that will be true whether the federal funds rate is at the zero lower bound or 1 per cent.
Building permits, which are an important leading indicator for housing starts and construction, increased by 12.9 per cent over the past year on a trend basis. By comparison, housing starts rose by 5.9 per cent over the same period. This implies that construction growth should improve over the next six months.
House prices are slowly providing an impetus for property developers to get moving. According to the Case-Shiller index, house prices rose by 1 per cent in March, following strong growth over the past six months, to be 5 per cent higher over the year. Property prices remain 13.1 per cent below their peak in April 2006.
Recent momentum points to stronger price gains over the remainder of the year and suggest that ongoing shortages may finally be contributing to price growth. Property remains fairly cheap by historical standards, particularly given income growth since 2008, and shouldn’t pose much of a problem for buyers in the near term.
Nevertheless, combined with a stronger US dollar, it does raise concerns about the competitiveness of US firms. It’s an important reminder that the property sector doesn’t operate in a vacuum, rising prices and activity inevitably spill over into the broader economy.
The final property indicator worth looking at it home sales. Property sales are often a useful proxy for demand, although it obviously also reflects available supply as well. This measure provides a less optimistic assessment of the US housing sector.
Measures of property transactions can also be a useful indicator of labour mobility and economic dynamism. By this measure, the US economy isn't as dynamic as it was before the crisis, which is consistent with the lengthy, but often uneven, nature of its economic recovery.
The Federal Reserve remains concerned about the US housing market and the lack of a recovery thus far. Nevertheless, there is cause for cautious optimism particularly with regards to housing construction. The current environment isn’t sustainable in the long term and population growth dictates that residential construction will need to rise rapidly over the next few years.
This will play a key role in what will eventually become an important economic transition. The housing and household sectors are set to dominate US economic growth in the medium term, supported by solid employment growth and the stronger US dollar.