The Strongest Sign Yet That Inflation Is Transitory

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Something seems to have changed in housing market psychology over the past month. Prospective buyers who find themselves in bidding wars might not have noticed it yet, but there are multiple signs that the market is beginning to cool.

Last week's consumer-price report, which came in much hotter than expected, made investors question whether inflation — turbo charged by reopenings and multiple rounds of fiscal stimulus — is only a passing phase. Fortunately for those who hope it is, rapidly shifting conditions are starting to provide evidence that, at least in the bellwether housing industry, rising prices are starting to cool demand. To the extent other industries begin to follow suit, that's a sign that whatever inflation we get over the next several months will end up being temporary.

Housing's a good industry to study because it was one of the first to boom after the onset of the pandemic last spring, so it might be a leading indicator of what we'll see from other parts of the economy over the next several months. New home sales started recovering last May, and by June 2020 were at their highest levels since the 2008 recession. Demand for both new and existing homes has remained strong since then, leading to dwindling housing inventories and a surge in the price of lumber that accelerated in the past six months. Anyone concerned about inflation risks needs to look no further than home prices up 15% over the past year and the price of lumber up by 400%.

The parabolic rise in lumber prices in just the past couple months was due in part to homebuilders scrambling to meet obligations they made earlier in the year. Maybe, for example, a builder sold a house to a buyer in January, but without locking in the price of lumber before construction. To complete the house in April they had to pay an exorbitant price, but that was still better than losing the sale or suffering the reputational damage of backing out of a contract.

Builders adapt quickly to market conditions, and the landscape now is different from January. There have been anecdotal reports of some builders deciding to pause or slow down rather than continue to operate in a market with such high prices. Those stories were backed up by some hard data in the April housing starts report, which showed that single-family starts for the month were at their second-lowest level since last August. The only lower month was February, when Texas was in a deep freeze.

Lumber prices are starting to respond to the pause. The July lumber futures contract has fallen by 25% from its May 7 peak, a sign that the market has found a level where buyers are balking rather than continuing to pay up. And for the first time since buying surged last spring, the inventory of homes for sale has increased for two consecutive weeks, a sign that normal seasonality might be returning.

To sustain a high level of inflation requires more than a temporary imbalance between supply and demand — it takes a conscious behavioral change from both buyers and sellers in support of higher prices. And while prices may have risen faster and higher than most participants expected, now the market is starting to behave like this has been a temporary imbalance rather than a structural shift in behavior. Not only are some builders choosing to slow down despite historically low housing inventories, sawmill companies aren't in a hurry to expand capacity, choosing to rake in what they see as short-term windfall profits rather than invest for future demand that they're not sure will materialize.

It might be that we're in a new economic environment that really will have structurally higher inflation, but decades of low rates have anchored the psychologies and behaviors of economic actors. If the response to high prices and low inventories throughout the economy is for buyers to pause while they wait for sellers to catch up on production, the result will be a start-and-stop growth environment — but one without the kind of sustained higher inflation that people fear.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Conor Sen is a Bloomberg Opinion columnist and the founder of Peachtree Creek Investments. He's been a contributor to the Atlantic and Business Insider and resides in Atlanta.

©2021 Bloomberg L.P.

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