Housing market flashes warning signs as Fed considers further rate hikes

The Fed’s fight against inflation is becoming increasingly complex. The housing market remains depressed despite widespread price pressures.

Separate reports on Tuesday said housing data worsened further in September, further worsening an already complicated policy landscape for the central bank as it considers its next move on interest rates.

Things seem likely to get worse before they get better. If the Fed raises short-term rates in the coming months as expected, mortgage rates, already set at 7.43%, could rise even further, further squeezing affordability. The rise in housing borrowing costs coincides with a general rise in inflation and a housing shortage.

“Unless Washington makes a 180-degree shift in policy and makes new housing more affordable, the housing market is going into a deep slumber,” said Chris Rupkey, chief economist at Fwdbonds. “It’s not winter yet, but homes are getting deep freeze.”

The Pending Sales Index, a forward-looking index that measures home sales that are under contract but not yet completed, hit an all-time low on record since 2001, the National Association of Realtors reported. The index fell 7.3% for the month and 11.3% year-over-year. Wall Street had expected a decline of just 0.4%.

Housing starts, another key metric in assessing market conditions, also fell by a much larger margin on Tuesday than had already been subdued expectations.

Private housing starts fell at a seasonally adjusted annual rate of 5.2% in the month, against expectations for a narrow 0.4% decline, and building permits fell 0.2%, compared with the Dow Jones consensus estimate for a 2% increase, according to Commerce Department data.

Furthermore, the number of permits for single-family homes remained at 845,000, down 4% from August and the lowest since 2023.

“September was a weak market due to the sharp rise in mortgage rates,” said NAR Chief Economist Lawrence Yun. “While job growth and rising incomes may support home purchases, housing affordability is significantly affected by changes in mortgage rates.”

According to Mortgage News Daily, 30-year mortgage rates were above 7% for much of September and ended the month at around 7.6%. Five years ago, interest rates were near 3%, fueling a coronavirus-era housing boom that saw demand explode and prices rise as a result.

Excluding pending sales, homebuilder sentiment is at its lowest in 14 years.

Depending on the situation, Fed officials could respond to the downturn in the housing market with easy monetary policy. Lower interest rates generally stimulate demand by lowering borrowing costs.

But the Fed has a bigger battle in its efforts to control inflation. Last week’s consumer and producer price data showed little sign of optimism, with wholesale final demand goods prices rising 2.6%, the fastest pace in a series of Bureau of Labor Statistics data since December 2009.

Fed officials said they are tracking the inflationary effects of strong investment in artificial intelligence, which is pushing up the prices of chips and electronics. At the same time, they believe the benefits from AI investments could offset weaker sectors of the economy, such as housing.

But Goldman Sachs economist Lonnie Walker said in a note to clients on Monday that the results generally indicate housing market conditions are likely to weaken further before stabilizing.

“We expect affordability headwinds, reignited by the recent rebound in mortgage rates, to become increasingly dominant in 2027, adding further weight to economic activity,” Walker wrote. “Sustained increases in mortgage rates will continue to have the most significant impact on home sales. Recent interest rate increases are likely to reduce existing home sales in the coming months.”

Several data points speak for themselves. More than 95% of mortgage borrowers receive a rate below the prevailing rate, and 65% receive a rate 2 percentage points below. Goldman expects housing investment to decline by 2.5%, 4% and 1% in the next three quarters, respectively, and could decline further if mortgage rates do not fall.

The company expects single-family home starts in 2027 to be just 875,000, about the same as this year, while existing sales are expected to be 3.9 million, also about the same as in 2026 but 26% below pre-COVID-19 levels in 2019. Walker believes this middling level is the product of a “lock-in” effect, where deteriorating affordability weighs on new construction while current homeowners find it too expensive to move, making borrowing costs higher.

“Housing activity has remained narrow in recent years, with upside capped by affordability headwinds, but downside cushioned by a long-standing housing shortage,” Walker wrote. “We expect headwinds from affordability to become increasingly dominant in 2027, further weighing on activity.”

Markets expect the Fed to keep its benchmark interest rate unchanged at next week’s meeting. But futures pricing suggests a quarter-point rate hike is likely in December and March 2027, according to CME Group’s FedWatch tool.

NAR economist Yun is optimistic that the trend of rising mortgage costs ahead of Fed rate hikes could mean interest rates will reach a plateau.

“Given that mortgage rates are already rising far faster than the Federal Reserve’s short-term interest rate hikes, there is a possibility that mortgage rates will hit a plateau,” he said. “Buyers and sellers may simply be holding off until mortgage rates become more favorable.”