The historical relationship between home sales and economic recessions is breaking down
It’s been a rough couple of years for the housing market following the Pandemic Boom that occurred between 2020 and 2021.
Total home sales fell 14%. New home sales fell 5%. The total amount spent on housing fell 10%. And this is despite the fact that prices have risen more than 6% over the last year.
Residential investment did rise a small amount in Q1 2024, but similar to the other statistics, it fell by 11% year over year in mid-2023. Figure 1 illustrates that outside of price increases, there were not many bright spots for housing in 2023.
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U.S. Housing Market at Odds With the Larger Economy
The housing market stands in sharp contrast to many other facets of the U.S. economy, and this relationship is counter to historical patterns. In 2023, U.S. unemployment remained at or below 4%, wages increased by 4%, and total U.S. GDP was up 2.5%.
Figure 2 shows new home sales and recessions from 1964 to 2010. The vertical black lines indicate drops when new home sales crossed a -10% threshold. During this 46-year period, new home sales dropped more than 10% annually eight times, and in six cases, a recession followed.
The relationship between home sales and recessions illustrated in Figure 2 is well documented. Research shows that housing downturns preceded nearly every recession in the 20th century going back to the Great Depression1. In the new millennium, however, the relationship has been shakier.
The recession in 2001 was not preceded by a housing downturn, nor was the Covid recession. However, the Great Recession was, making the ratio of housing market downturns preceding recessions 1 out of 3 for this century compared with 8 out of 9 in the last century.
This changing relationship combined with the most recent housing downturn not tipping into a recession begs the question of whether housing is now decoupled from the broader economy. If so, perhaps it is no longer appropriate to consider a housing market downturn as a leading indicator for recessions.
Why Are Housing Downturns No Longer Leading to Recessions?
Some research has suggested that the stringency of land use requirements could be behind the diminished connection2 between the two phenomena. This theory works in conjunction with interest rates — when they drop demand increases.
A drop in interest rates should result in more residential investment and therefore more new home sales, but when there are fewer inventory options available in addition to a longer, more costly permitting process, this relationship becomes unstable.
However, zoning stringency is not the only possible cause of this decoupling. When interest rates are raised, this only affects new homebuyer mortgages or people with adjustable-rate mortgages (ARMs).
Low Pre-Pandemic Interest Rates May be Buoying the U.S. Economy
For the vast majority of borrowers who have fixed-rate mortgages, rate increases have no impact on their monthly payments. So, unless they lose their job, they are shielded from the direct consequences of rate increases.
Figure 3 shows why this is particularly prevalent today. By borrower count, 30% of borrowers have a rate under 3%, and 60% of have a rate below 4%. Borrowers keep these low fixed-rates for the duration of their mortgage, so rate increases do not force them to reallocate their funds into servicing additional debt and they can maintain their habitual consumption of other goods and services. In such circumstances, there is less reason for businesses to reduce their hiring activity because sales remain high, and therefore, there is no rise in unemployment.
For most of the 20th century, housing had been a reliable bellwether for the rest of the economy, but today that no longer appears to be the case. The breakdown in this connection will make it more difficult to effectively predict economic fluctuations.
Just look at the post-pandemic landscape. In 2022 there were widespread predictions of an impending recession, based primarily on the poor performance of the housing and mortgage markets. But those predictions never came to fruition and threw into sharp relief the question of whether the relationship between housing and the larger economy has altered permanently3.
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1 Edward E. Leamer, 2007. “Housing is the business cycle,” Proceedings – Economic Policy Symposium – Jackson Hole, Federal Reserve Bank of Kansas City, pages 149-233.
2 Green, R. K. (2022). Is housing still the business cycle? Perhaps not. In Handbook of real estate and macroeconomics (pp. 269-283). Edward Elgar Publishing.
3 There is still the possibility that a recession could occur in near future, but such an occurrence cannot necessarily be tied to recent housing market movements.
