What We Expect in Housing and the Economy in 2020
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Housing has been a bright spot in an economy gripped by uncertainty in 2019. Economic growth has slowed meaningfully, and confidence in the outlook has weakened, leading the Fed to transition from raising rates in 2018 to cutting rates this year. The business sector has been a focal point of weaker data as companies try to navigate the vagaries of the trade war between the United States and China, and other global trade risks like Brexit.
This fall of confidence has led to declines in the 10-year Treasury interest rate that have been very beneficial to the housing market. Mortgage rates are more than 100 basis points lower than in November 2018, increasing homebuying activity, homebuilder confidence and creating a refinance boom that may be the largest in more than a decade. Home-price increases continue, though at a more moderate pace — a welcome development given affordability challenges. Loan performance continues to make records with low delinquency and default rates. These factors have led the housing market to outperform expectations in 2019 from the previous year.
After exceeding expectations in 2019, the question everyone is asking is what’s ahead for the housing market in 2020?
As always, the rates picture will play a key role. After the declines in 2019, it’s difficult (but not impossible) to see rates falling much further. The lingering uncertainty about the economy, stemming in large part from the trade war, could escalate in an election year. From the Trump administration’s perspective, a trade deal with China could be a useful talking point for an election campaign. On the other hand, it may be helpful to have the trade war as a foil. It will come down to the political calculus on how voters interpret the economic impacts of the trade war. The manufacturing sector is most directly impacted by the disruption to trade, and many measures suggest it’s already in recession. Key manufacturing states, such as Michigan and Pennsylvania, were closely fought battlegrounds in 2016 and are suffering disproportionately from the trade war. And that might motivate a resolution with more urgency.
For the broader economy, the trade war is resulting in lower business confidence, expressed in slowing capital expenditures and hiring. Business investment is declining and the labor market is on track for the weakest job growth since 2010. Further deterioration in these measures could spur a resolution to the trade war. A deal could help accelerate growth in 2020, particularly if consumers gain more confidence in their job prospects and wages. After all, higher earnings mean consumers are more likely to spend more, helping boost the economy.
In reality, no one really knows with certainty what the outcome of the trade war will be. So while significantly lower rates seem unlikely, they cannot be ruled out if the trade war continues. The baseline is for flat to somewhat higher rates. What are the implications for housing?
Fundamentally, the medium- and long-term prospects for housing are good because demographics will continue to support demand. The millennial generation is 73 million people with a median age of 30. They are now entering their peak homebuying years, though not without challenges. Student debt has been identified by many millenials as delaying or preventing them from pursuing homeownership. Later and fewer marriages and children also lead many people to postpone buying a home, though, we are seeing more single homebuyers as lifestyles adjust. Although the homeownership rate is lower today than for previous generations at a comparable age, the sheer size of the millennial generation bodes well for housing demand.
In 2020, with flat to moderately higher rates and a stable non-recessionary economy, the demographic dividend should lead to an increase in the pace of home sales. With home prices still increasing at or above incomes, though, affordability will still keep some homebuyers out of the market.
- Mortgage rates: Could increase about 50 basis points (bps) in 2020, moving above 4%
- Home sales: Should increase marginally by 2% to 5% year over year
- Home prices: Growth will moderate to about 3% year over year
- Housing starts: Up 5% year over year
- GDP: Slows to 2% in 2020, down from 2.2% in 2019
- Unemployment rate: Unchanged at 3.4% by year-end 2020 from 3.4% at the end of 2019
- Fed funds rate: Fed should be on hold as the economy muddles along
Mortgage interest rate changes will continue to dominate the housing market in 2020. The 100-plus bps decrease in rates since November 2018 has boosted affordability. It also lifted sales somewhat and accelerated refinancing activity significantly in 2019.
- Prediction: Expectations in 2018 for 2019 were that rates would increase, but instead, they fell over 100 basis points. This illustrates the uncertainty of the rate outlook and cautions against placing too much weight on any specific rate expectations. Still, our prediction is that rates are more likely to increase than decrease, given the declines to date and the easing of recession concerns. A trade deal would be a significant boost, potentially increasing our baseline by 50 basis points and mortgage rates rising above 4%.
- Risk: Growth concerns or even a recession could be on the horizon, driven by political risk. An escalation of the trade war and slower global growth could hold push rates lower.
Housing sales cooled early in 2019 but recovered late in the year as lower rates boosted demand. In the year ahead, we should see modest gains, especially given how weak sales were early in 2019.
- Prediction: Flat to slightly higher rates will support sales. Sustained, though slower, labor market growth and increasing numbers of millennial buyers entering their peak homebuying years will support demand. Expect sales to expand modestly by 2% to 5%.
- Risk: Recessionary lower rates could slow the housing market more if homebuyer confidence and banks’ willingness to lend fall. However, it’s unlikely we’ll see a slowdown like the financial crisis.
Home price appreciation cooled in early 2019 as housing demand was muted in its response to lower rates. A sharp increase in home prices compared to incomes since 2012 means incomes are anchoring prices somewhat.
- Prediction: Price increases are likely to slow regardless of what happens to interest rates and sales. The run-up in prices since 2012 totals 58%, compared with a 24% increase in median household income. As a result, home prices are approaching levels that may be unsustainable when compared with income. Home price growth will moderate to about 3% year over year.
- Risk: There may be some localized price declines, particularly in cities where affordability has become a challenge, but we don’t expect a national decline.
Housing supply has been a significant challenge since the financial crisis — an issue that will persist in 2020. In particular, supply has tightened at the lower-priced segment of the market for a number of reasons. Two of those key reasons are the increase in real estate investors who are scooping up affordable homes to rent out and the lack of new building as home builders gravitate to more lucrative, higher-priced homes.
- Prediction: Housing starts should increase in 2020, continuing momentum from late 2019 that is supported by lower rates. Still, an increase of about 5% in starts will do little to alleviate the supply crunch.
- Risk: Presidential candidates are looking at housing legislation to boost supply. Uncertainty about the path of future regulations might spur some increased activity ahead of the election.
GDP growth in 2020 will be about 2.2%, down from 2.9%. The key contributors to growth are consumer spending and residential investment as a solid labor market helps consumers. Private investment was weakened by the trade war, which also create a drag on net exports.
- Prediction: Leading economic indicators suggest economic growth will continue to slow in 2020 to about 2%. Strong consumer spending should continue to support growth, but the uncertainty will weigh on other sectors.
- Risk: GDP growth may decline more than expected if consumer confidence becomes tepid. Consumer confidence has a history of sharp declines when confronted by external shocks. If trade disputes are not resolved, a slowdown in global economic growth could dampen the U.S. economy as well.
The labor market has supported growth as the unemployment rate has reached a 50-year low of 3.5% in 2019. The number of open jobs exceeds the number of job hunters, suggesting strong demand for workers. That’s leading to some acceleration in wages.
- Prediction: We expect unemployment rates and jobless claims to remain low. Although a significant decline in the unemployment rate is unlikely, it may dip to 3.4%. We also expect wages and nonfarm payrolls to advance modestly.
- Risks: Sustained weakness in business confidence has already led job growth in 2019 to be the weakest since 2010. If companies transition from slower hiring to actual job cuts, the unemployment rate could shift higher.
The Fed has lowered its benchmark rate three times in 2019 and could cut one more time for a total of 100 basis points in cuts.
- Prediction: The FOMC will likely be on hold early in the year as it assesses the impact of its cuts so far. If growth declines just moderately in 2020 as currently expected, the Fed would stay on hold throughout the year.
- Risk: Elevated political uncertainty and unresolved trade wars could weaken the economy and push the Fed to act. Additionally, if inflation fails to pick up despite the cuts so far, the Fed may feel it has room to act. Still, mortgage rates have moved lower well ahead of the Fed and might not decline in tandem.