The Federal Reserve has long been able to depend on the housing boost from interest rate cuts juicing the US economy. This time looks different.
More than a percentage point of central bank easing and another percentage point of expected easing have done little to reassure the residential construction industry. As buyers stay on the sidelines, a growing pessimism about the near-term outlook is taking hold among companies. It’s unlikely that the rate-cut trajectory we’re currently on will halt a decline in construction activity and employment, an ominous sign for economic growth and the labor market next year.
The strongest, but by no means only, piece of evidence we have for this came last week from America’s second-largest homebuilder, Lennar Corp. Unlike most rivals, Lennar’s strategy is to keep housing production steady and let profit margins move up and down as market conditions change. In its view, this is a more efficient model when it comes to land and labor relationships than adjusting production levels in response to demand volatility. So it was noteworthy that Lennar finally acknowledged that the weak housing market no longer supports the level of production the company has maintained, and executives decided to trim activity while they wait for things to stabilize.
There are two main reasons they did this. First, Lennar’s profit margins are hovering around the lowest levels since the late 2000s as use of buyer incentives such as mortgage rate buydowns have climbed. Incentives now amount to 14.3% of average sales prices versus 5-6% normally, according to Bloomberg Intelligence. And second, more ominously, despite the decline in mortgage rates “stronger sales have not yet followed,” according to Chief Executive Officer Stuart Miller.
Lennar’s downbeat outlook has been echoed in warnings from other companies tied to residential construction.
Interfor Corp., one of the largest lumber producers in the world, plans to reduce production by 12% between September and December in response to weak market conditions and economic uncertainty. Executives at Core & Main Inc., a provider of infrastructure services, said that lot development for single-family housing slowed during the quarter, “especially in previously fast-growing Sun Belt markets,” sending its stock price down 25% on Sept. 9. Boise Cascade Co., which supplies engineered wood products for new residential construction, cut its profitability guidance last week. The National Associations of Home Builders Market Index, which captures the sentiment of mostly smaller homebuilders, remained near its lowest level since 2012 in September.
So, the best evidence we have from the industry indicates that mortgage rates at about 6.25% are just not low enough to boost demand for new homes. In response, companies in the residential construction supply chain, which have been hoping for a turnaround since the Fed first cut rates last September, are curtailing their investment and production activity for at least the next several months. Even though the housing market has been sluggish for three years, construction employment only recently began to decline. Job cuts will likely increase over the next several months, putting pressure on a labor market that’s already struggling to maintain a semblance of balance.
How can the residential housing market be so weak when it’s commonly believed that there’s a shortage of homes in the US and the Fed is cutting rates? “We're going to have to find, frankly as an industry, a way to build and deliver homes at a more affordable level and that is all going to derive from cost structure,” Lennar’s Miller said. In other words, homes need to be cheaper, land needs to be cheaper, labor needs to cost less, and/or interest rates need to be lower. At 2019’s affordability levels, we might have a housing shortage; at 2025 affordability levels, homebuilders are fighting off weak demand and responding to deflationary pressures.
At a time when investors and policymakers are weighing the risks from both the labor market and inflation, the slump in residential construction is the best evidence to stay focused on jobs. The benefit of interest rate cuts is limited at a time when housing affordability remains poor and workers are increasingly worried about losing their jobs. There are few more reliable recession signals than a downturn in construction employment, and with more cost cutting likely over the next few months, the time to prevent another recession is running short.
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