The severe contraction in the US housing market over the past year looks like it may be coming to an end, and the bottoming-out is raising hopes on Wall Street that the country could avoid a recession altogether.

That’s because historically, housing has been a critical driver of the broader business cycle. Low interest rates can boost demand for homes, which drives up prices, building activity and construction jobs. Higher prices also help support consumer spending through the so-called “wealth effect.” And when the Federal Reserve raises rates, it all tends to go in reverse.

Now, with the Fed poised to wrap up its tightening campaign — perhaps next week — mortgage rates have probably peaked. Meanwhile, the job market has remained resilient. And all of that has helped key housing indicators rebound in the early months of 2023.

Ellen Zentner, the chief US economist at Morgan Stanley who has stuck to her call for a “soft landing” even as many others have thrown in the towel, says it may save the economy.

“It seems pretty clear when you look at the activity data, both home building and home buying, that we’re rounding the bottom now,” Zentner said. “If you’re thinking about it in the traditional way, that the business cycle is pretty much the housing cycle, then that’s another piece of evidence that you can actually have a soft landing.”

Most economists expect the US to fall into a recession sometime in the next year, as the Fed’s aggressive interest-rate increases to tame inflation dent growth and raise unemployment. How severe, or how “hard” a landing that will be, is debatable.

The key is the labor market, which has shown remarkable resilience despite a year’s worth of rate hikes. So long as people are employed and making a good income, they’ll remain able to buy and sell homes — especially if mortgage rates don’t go up any further.

Right now, things are looking up: New-home sales jumped in March to the highest level in a year, according to government data out Tuesday. And home construction projects have risen about 6% over the last two months after falling 26% in the preceding nine months.

Buyers have largely been gravitating toward new construction since there’s limited inventory on the resale market, as many existing homeowners with low mortgage rates aren’t listing their properties. That’s kept sales of previously owned homes depressed, but they’re also starting to turn the corner — those sales in March were 11% above January’s low.

Lower mortgage rates and home prices could bring in more buyers. The S&P CoreLogic Case-Shiller index of prices in 20 US cities in February was nearly 5% below last year’s peak, according to data published Tuesday. They jumped more than 40% from June 2020 to June 2022.

“Recent drops in house prices and mortgage rates have led to an increase in mortgage purchase applications and more pending home sales, showing even a small boost in affordability will bring buyers back,” Oren Klachkin and Ryan Sweet of Oxford Economics said in an April 21 report.

With the housing market poised to return to growth, it could help limit the pain in the rest of the economy when the full impact of the Fed’s rate hikes — and tighter credit conditions after multiple bank failures — materializes.

Remarkably, one of the strongest industries within the labor market has been construction. While the sector last month posted its first decline in headcount in more than a year, payrolls are still near a record high.

“It reduces the probability” of a hard landing, said Michael Feroli, the chief US economist at JPMorgan Chase & Co. who still forecasts a recession will begin in the fourth quarter. “It may be the case that if housing is a little more resilient, you’ll need to see weakness elsewhere in the economy.”

Still, Feroli cautioned that a wave of construction layoffs “is maybe just beginning,” pointing to the increasing length of time it’s taken in recent years to build homes. That means a decline in new projects can take longer to have an impact on employment than in the past.

Zentner isn’t particularly optimistic about construction jobs, either. But she thinks elevated home prices, which Morgan Stanley expects to decline by only about 4% in 2023 amid ongoing tight supply, will help support consumer confidence and spending going forward.

That supply-demand dynamic is also why Ed Leamer — the University of California, Los Angeles economist whose influential 2007 paper, “Housing IS the Business Cycle,” laid out the importance of residential investment to the economy — thinks last year’s sharp contraction in the housing market won’t weigh as heavily as it has in past cycles.

“Recessions historically have been about two fundamental job losses, which are construction and manufacturing. Those two things are not going to be so serious this time,” Leamer said. “There wasn’t really any over-building, so we don’t need to have significant under-building to get back to a normal level in housing.”

--With assistance from Augusta Saraiva.

This article was provided by Bloomberg News.