The Federal Reserve’s Housing Recession Dilemma

They say housing leads the economy in and out of a recession. Currently, housing starts are back at the levels seen during the COVID-19 recession in 2020. Interestingly, employment for residential construction workers — typically one of the first areas to experience declines before a recession — has not yet seen its usual downturn. Several factors have been keeping labor steady, such as working through a backlog of orders and long turnaround times to complete projects. 

Perhaps most importantly, some homebuilders have been subsidizing mortgage rates to help maintain employment and finish ongoing projects. 

The key points of this report indicate that the Federal Reserve has overlooked the housing market for years. The existing home sales market does not align with their dual mandate of ensuring stable personal consumption expenditures (PCE) or consumer price index (CPI) prices, as these measures account for rent. Instead, the existing home sales market is more about transferring commissions rather than causing significant job losses in the economy. 

On the other hand, the new home sales and housing starts sector does affect future housing production, which is crucial for addressing rent and home price inflation. This sector is closely tied to the overall economic cycle and tends to show patterns before every recession observed in recent modern history. 

With the labor market cooling down — particularly in the private non-farm payroll data — can this sector be completely ignored in 2025? We will soon find out. As 2024 comes to a close, the Fed has managed to overlook these issues for another year due to the factors mentioned above. However, those factors are becoming increasingly precarious as we move into 2025.

Let’s take a closer look at the data.

Housing starts at recession levels, permits get a slight boost

From Census: Housing Starts: Privately-owned housing starts in November were at a seasonally adjusted annual rate of 1,289,000. This is 1.8 percent (±10.6 percent)* below the revised October estimate of 1,312,000 and is 14.6 percent (±11.7 percent) below the November 2023 rate of 1,510,000.

Building Permits: Privately-owned housing units authorized by building permits in November were at a seasonally adjusted annual rate of 1,505,000. This is 6.1 percent above the revised October rate of 1,419,000 but is 0.2 percent below the November 2023 rate of 1,508,000

Last month, I discussed the challenges of building millions of extra homes in the near future due to restrictive housing policies, as indicated by recent data. However, despite these challenges, we have not lost our labor pool of construction workers. It’s important to note that remodeling workers comprise a significant portion of the residential construction workforce.

As short-term interest rates decrease, some lending opportunities, such as land purchases and apartment financing, are improving. However, housing starts have declined for some time, as shown in the chart below. If mortgage rates hadn’t dropped from 7.5% to around 6% earlier this year, we would have experienced even more job losses in the construction sector. We did see one negative labor report before this decline in rates, although single-family permits have shown a slight increase in the most recent report.

As the total completed units for sale increase across America, the builders will be more mindful about their production with elevated mortgage rates and if for some reason mortgage rates go higher, we can see what it did to the housing starts data earlier in the year and the residential construction data as well. This is why Sarah and I recently discussed this being the wild card for housing in 2025.

In 2025, I want to monitor whether mortgage rates remain high or increase further. Specifically, I’m interested in how long it takes for builders to start laying off workers if demand weakens due to higher rates. At this point in the economic cycle, there is a risk of recession in 2025 if new home sales data gets softer. This concern arises because housing completion data is higher than the number of housing starts and permits.

We have already seen the negative impact of 7.5% mortgage rates on this sector in 2024, so it will be crucial to track all economic data, focusing on the housing sector as it could be a critical factor for the Fed to prevent a recession. Since the Fed is meeting today, I hope one reporter asks them this question since Chairman Powell noted in the last meeting that housing was weak.