As of October 9, 2023, the macroeconomic data in the United States paints a picture of an economy that continues to outperform expectations, despite looming concerns of a potential recession. The labor market remains a bright spot, with a significant uptick in job creation in September, indicating that the shortage of available workers persists. However, this robust economic performance has given rise to fears that inflation may take longer to return to the Federal Reserve’s targeted 2% rate.
This suggests that interest rates are likely to remain at elevated levels, impacting various sectors of the economy. In California, the housing market is feeling the impact, as demand wanes, transactions falter, and sellers are increasingly resorting to price reductions. Nevertheless, desirable homes that are priced appropriately continue to attract significant demand, even as mortgage rates reach their highest levels in over two decades.
Strong Job Market and Its Implications
One of the significant indicators of the U.S. economy’s robustness is the performance of the labor market. In September, the country experienced the largest gain in employment in 2023, with 336,000 net new jobs created. This job market resilience has proven to be impervious to a housing market that has been somewhat lackluster and the rise in interest rates, which, theoretically, should impact hiring.
The national unemployment rate held steady at 3.8%, with forthcoming data for California anticipated to be released soon. Additionally, new unemployment claims in California remained consistently below 40,000 for two consecutive months. These figures, while indicative of a slow decline in inflationary pressures due to persistent labor shortages, also highlight the economy’s overall resilience in the face of domestic and global challenges.
Inflation Data and Interest Rates Still Have The Biggest Impact
While a strong job market is generally considered a positive economic indicator, it has raised concerns about the trajectory of inflation. A prolonged period of inflation above the Federal Reserve’s 2% target can result in higher interest rates. Consequently, the central bank may be compelled to maintain elevated interest rates for a more extended period, which is a potential cause for concern in the real estate market.
The strength of the U.S. economy, coupled with the need to control inflation, has been a driving force behind the recent surge in interest rates. These higher rates have implications for various sectors, including the real estate market (unfortunately)
The Federal Reserve’s Commitment
The Federal Reserve has communicated its commitment to keeping interest rates “higher for longer,” as emphasized during its recent Federal Open Market Committee (FOMC) meeting. This commitment stems from the strength of the economy and the need to control inflation. The probability of another rate increase during the November meeting is estimated at 11.5%, with the futures market indicating a 25 basis-point increase in the Fed Funds Rate at the December FOMC meeting. These expectations have contributed to the sharp rise in 10-year Treasury rates and have, in turn, led to increased mortgage rates. As of last week, the Freddie Mac 30-year fixed-rate average climbed to nearly 7.5%, marking the highest level in over two decades.
The rise in Treasury rates has contributed to an adjustment in the yield curve. The yield curve measures the spread between 2-year and 10-year Treasury rates, and it typically correlates with the likelihood of future recessions. An inverted yield curve, where short-term rates exceed long-term rates for an extended period, often precedes economic downturns. However, the recent adjustment indicates that the perceived short-term risks are diminishing in comparison to longer-term structural issues. While this adjustment might imply expectations of slower economic growth, it also suggests reduced immediate uncertainty, as demand for 2-year bonds remains relatively stable.
California Real Estate Market as a Whole
The California real estate market has been significantly impacted by the confluence of a strong U.S. economy and rising interest rates. One of the primary consequences of the economic landscape has been the effect on home prices in California. The severe lack of housing inventory in the state has, to some extent, shielded home prices from the adverse impact of rising interest rates in 2023.
Year-over-year price growth has recently turned positive, signaling a degree of resilience in the face of these challenges. Despite the inventory shortage preventing a substantial recovery in home sales, transactions have held on to modest gains achieved since interest rates reached 7% last year.
The Impact on Buyer Demand
However, the recent surge in mortgage rates poses a challenge to the California real estate market. Buyer demand is showing signs of slowing down, and reports from REALTORS® indicate an increase in transactions falling out of escrow in the previous month. Market competitiveness has also subsided, reflected in the rising median days on the market and an increase in property discounting. Furthermore, the median time on market for active listings, representing homes that have not yet sold, is rising more rapidly compared to closed transactions. This indicates that unsold homes are lingering on the market longer, pressuring sellers to offer concessions to attract buyers.
The Impact on Commercial Real Estate
The impact of the U.S. economic landscape and rising interest rates extends beyond the residential real estate market, significantly affecting the commercial real estate sector. In particular, the office and retail sectors are grappling with challenges driven by remote work trends, e-commerce, and maturing commercial mortgages. Major employment centers in California have witnessed a surge in office vacancy rates, with cities like San Francisco and Los Angeles experiencing rates in excess of 20%. Absorption in these markets has also turned increasingly negative, contributing to pressure on office rents.
This, in turn, has led to an increase in delinquent remittances on office mortgage-backed securities (MBS). While the office CMBS delinquency rate had dropped to 2.4% in the first quarter of 2022, it has since risen to 4.3% in August 2023. The retail CMBS delinquency rate had seen some improvement after the pandemic but resumed an upward trend in May this year, currently standing at double its pre-pandemic levels.
My Personal Take
In conclusion, the current state of the U.S. economy, marked by a robust labor market, rising interest rates, and the consequences for the California real estate market, paints a complex and multifaceted picture. The U.S. economy’s strength and the Federal Reserve’s commitment to keeping interest rates elevated are at odds with concerns over inflation and the impact on the real estate market.
The California housing market has shown resilience in terms of home prices but is experiencing a slowdown in buyer demand and an increase in transactions falling out of escrow. Understanding the nuanced interplay between these factors is crucial for stakeholders across various sectors as they navigate an evolving economic landscape.
If you have any question, comment, or concern, feel free to reach out to our team at info@chadvorealestate.com.
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