“Housing downturns have preceded every U.S. recession since World War II,” wrote William R. Emmons, senior economic adviser for the St. Louis Fed’s Center for Household Financial Stability.
Emmons looked at recent movements in four housing indicators:
He found that they resemble patterns seen in the late stages of past expansions. (For figures showing these trends, see the Housing Market Perspectives article “Recession Signals: Four Housing Indicators to Watch in 2019.”)
Though several housing indicators suggest another housing downturn may be on the horizon, a broader economic recession is by no means inevitable, he noted.
“[S]ome past episodes of housing weakness have proved to be false alarms,” the author wrote.
However, if the housing market were to weaken further, the risk of a recession certainly would be higher, Emmons noted. He pointed out housing’s forecasting track record: A housing downturn is necessary but not sufficient for a recession to occur.
Emmons explained how these four housing indicators behaved before the past three recessions.
By taking the average quarterly interest rate on a 30-year fixed mortgage and subtracting the average rate during the previous three years, one can see a pattern in the movement of interest rates. The author described this three-year average as “recent levels.”
“[M]ortgage rates generally rise above their recent levels in the final years of an economic expansion,” Emmons wrote. “By the time a recession begins … mortgage rates already have declined below their recent levels.”
Like with 30-year fixed mortgage rates, a pattern can be seen in the difference between the average rate of existing single-family home sales during the past four quarters and the average sales rate during the previous three years.
“[H]ome-sales activity was strong relative to recent levels for two to three years before the eventual recession, but then dropped toward or below its three-year trend line in the year or two just before the recession began,” Emmons wrote. “The cyclical momentum of home-sales activity reached its nadir near the onset of each of the previous three recessions.”
Real (or inflation-adjusted) house-price changes varied widely during the three most recent business cycles, Emmons noted.
“[T]he momentum in real house prices declined sharply two full years before the most recent recession began and stayed low for several quarters after,” he said.
Emmons noted that the contribution of residential investment to gross domestic product (GDP) growth represents the most direct link between housing cycles and business cycles.
“The Great Recession period again stands out as a particularly severe housing downturn,” the author wrote. “Housing investment also clearly lost momentum well before the 1990-91 and 2001 recessions.”
However, Emmons noted that not all housing indicators point to a slowdown.
“It is not difficult to find housing-related indicators that are less gloomy,” he wrote. He pointed to employment in residential construction, which increased 7.1 percent in the year ending the third quarter of 2018.
Emmons also noted that his analysis of the trends showed that the degree of advance warning from any particular signal has varied substantially.
“All four indicators have also generated false alarms—instances of housing weakness that were not followed by a recession within the next few years,” he said.
Still, the author noted that several indicators of the housing-sector momentum currently line up reasonably well with patterns seen before the past three recessions.
“This is no guarantee that a recession will begin within the next year or two, but evidence suggests that housing-related indicators warrant careful monitoring,” he concluded.