The Next Leg Down For House Prices Will Be Unemployment

Despite rising interest rates over the past 18 months, house prices across much of the developed world have held firm. In the Euro area, house prices for the first two quarters of 2023 have fallen by less than 1% and in the US, although 1.2% lower compared to 12 months ago, house prices have started rising again. Many analysts have been taken by surprise.

Compounding supply and demand imbalances is the reluctance of many homeowners to sell and re-finance new homes at higher interest rates. This is causing major shortages of listings which prevents house prices falling further than expected.

Have economists been looking at the wrong data?

Historically, price volatility in housing is correlated with the unemployment rate more so than with interest rates per se. When jobs remain plentiful and incomes continue rising, higher interest rates may cause house prices to moderate but severe deflations are rare. 
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When unemployment rises, however, falling incomes lead to forced selling and forced selling leads to more supply. As supply increases, prices begin to fall. It is now buyers who sit out of the market either unemployed or waiting for prices to fall further.
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The graph below charts the unemployment rate and house prices in the US for the period 1970 - 2009. Throughout most of the cycle, as the unemployment rate rises, house prices fall. This is most noticeable in the early 80’s and 90’s.
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The outlier is the 2001 recession when both house prices and unemployment rose together. The enormous credit expansion by banks and irresponsible lending during that period kept house prices elevated. Normal service resumed, however, in 2008/9 when, following the financial crises, a dramatic rise in the unemployment rate caused house prices to collapse by around 30%-40%. During the less severe recessions of the 1980s and 1990s, house prices fell by between 7%-10% in the worst affected areas.

​In every cycle it’s important to understand what causes the unemployment rate to rise in the first place. The next graph charts interest rates and unemployment for the same 30 year period. As you might have guessed, a sharp rise in interest rates preceded unemployment each time.

For instance, interest rates rose from 3% to 12% between 1972 and 1974. This corresponded to a large uptick in unemployment in 1974.

Similarly, in 1981 when interest rates reached 19%, unemployment rose to 10% in 1983.
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We can see the same trend occurring again in 1989 when interest rates hit 9%. This preceded the unemployment rate rising to around 8% in 1992.

In 2000, interest rates rose to 6% causing the stock market to crash and the unemployment rate to rise in 2002.

And in 2006 when interest rates rose to 5.5%, the financial crisis followed in 2008.
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What’s striking about the data is the lagged effects of interest rates on unemployment.
In almost all cases, it took about 2 years for interest rates to start affecting the unemployment rate. As a debt-based economy, consumer spending eventually falls and businesses adjust to higher costs of capital.
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Given that the Fed and the ECB started raising interest rates in early 2022, a downturn is due sometime early next year based on historical data. Indeed, economic activity in the G7 countries this year has already started to decelerate.

GDP growth rates of G7 countries from 2000-2023

(Source: Statista.com)

Will lower GDP growth lead to unemployment? My best guess is that it will.
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As reported by the US labour department in July and again in August, US job openings have slowed to their lowest level in over two years. As seen in the chart below, US corporate profits are also in decline. A Purchasing Managers Index (PMI) report by AIB for July shows a fourth consecutive month of contracting output for the Irish manufacturing sector and the steepest decline since May 2020. Bearing in mind China’s difficulties and the German economy in recession, global growth is at an inflexion point.

Corporate profits in the United State 2012 - 2023

(Source: Statista.com)

According to the New York Fed this month, credit card debt in the US passed a milestone of $1 trillion. The average interest rate charged on credit cards in the US now stands at a whopping 20.53%. The Fed cite rising costs of living and declining savings rates for the spike in personal debt. Savings in the US are now below pre-pandemic levels.

​​Consumer savings in the EU fell sharply since the pandemic too with consumption peaking around the third quarter of 2022. The money supply in the Euro area has also contracted for the first time since 2010. As interest rates rise, the demand for borrowing falls. As banks make fewer loans, money in the economy dries up.

Monetary Aggregates in the Euro area (Annual growth rates)

(Source: ecb.europa.eu)

Add the hawkish tone regarding inflation from the central banks last week at Jackson Hole and it’s more and more likely that labour markets worldwide will soften over the next 6-12 months. A ‘higher for longer’ policy stance by central banks paints a fairly negative picture for growth and jobs. While property markets have avoided the worst, the next leg down for house prices could be unemployment.