Fed Tanks Housing Market

Housing starts dropped sharply in September to an annual rate of 1.2MM vs. expectations of over 1.3MM and last month’s level of 1.3MM.  We had expected the housing market to weaken in response to the 100 bp move in the 10-year which was exclusively driven by ultra hawkish Fed commentary that caused Fed funds futures to rise by over 150bp since the beginning of the war.

Fed policy primarily impacts the housing market and other interest rate sensitive sectors such as construction spending and consumer durables consumption.  The Fed’s hawkish monetary policy stance is irrational as the housing sector and construction sectors were already in a mild recession before the Fed started its tightening cycle.  With the 30-year mortgage now in the 7.5% area we are very likely to enter a deep housing recession.  Eleven out of twelve post WWII recessions were caused by housing declines triggered by Fed tightening.  We are dangerously close to triggering the Hatfield Recession Rule which states that a recession occurs when housing starts decline below 1.MM, which is the level breached in those 11 recessions.

We may avoid a recession during this irrational Fed tightening cycle due to the AI boom, but the Fed has also put that market at risk by effectively closing the high yield market to AI infrastructure companies.  We continue to forecast that the Fed will only raise rates one more time as it slowly realizes the negative effect of its hawkish policy has had on both the housing and financial markets.  We also forecast that the 10-year stabilizes in the 5% area, which is 100bp over the likely terminal Fed Funds rate