The last two weeks have provided a vivid reminder of how sensitive markets can be to small changes in the macro-economic outlook.

With a nudge down in oil prices, the Fed’s 2% inflation goal suddenly seems achievable within a matter of months. With a slight weakening in the labor market, the unemployment rate has shifted to a trajectory that has foreshadowed recession in the past. In response, the 10-year Treasury yield fell from 4.29% on July 24, to 3.78% on August 5 while the VIX index, a measure of stock market volatility, more than doubled over the same period, with stock prices falling sharply by the close of business last Monday.

Over the rest of last week, both interest rates and stock prices recovered, but they are clearly vulnerable to any new surprises on inflation or the labor market.

More broadly though, this game of inches on inflation and the labor market reflects a similarly close call on economic growth itself. 2.5% real GDP growth would revive fears of inflation. 1% growth would stoke fears of recession. Growth of 1.5%-2.0% would probably be judged to be just right, allowing for a continued slow slide in interest rates and steady growth in corporate earnings.

The Importance Of Housing 
With the economic outlook so finely balanced, even small sectors of the economy can have an important impact on the financial environment. Such is the case with housing.

In the second quarter of 2024, U.S. homebuilding accounted for just 4% of GDP. However, over the past 25 years, the sector has been three times as volatile as GDP overall, making it an important swing factor in determining the overall direction of the economy.

Following a frenzy of homebuilding in early years of this century, housing activity slumped in the Great Financial Crisis, with starts plunging from a peak of over 2 million units in 2005 to less than 600,000 in 2009. Thereafter, activity recovered very slowly but steadily to just under 1.3 million units in 2019. The housing industry saw less interruption than most other sectors from the pandemic and, in a post-pandemic economic surge, housing starts climbed to just over 1.6 million in 2021. However, high prices and rising interest rates then took a toll with starts falling to 1.553 million units in 2022, 1.420 million units in 2023 and an annual rate of 1.378 million units in the first six months of this year.

We expect that the July construction report, due out this Friday, will show further weakness with starts falling to an annual rate of 1.326 million units. But where homebuilding goes from there depends principally on three factors: demographics, inventories and affordability.

Demographics: A Stabilization In U.S. Population Growth
Starting with demographics, the U.S. Census Bureau does a woefully bad job in what is presumably its primary task—that is estimating and publishing accurate and timely information on births, deaths, net immigration and the overall growth of the population. Nevertheless, it is possible to piece together a reasonably coherent picture of U.S. demographic trends from a hodge-podge of other sources.

A good starting point in assessing current U.S. demographic trends is to look at the components of population growth for the year ended on June 30, 2023, which Census reported, (with its usual urgency), in the middle of last December. In that year, according to the official numbers, there were 3.653 million births, 3.149 million deaths, net immigration of 1.139 million and overall population growth of 1.643 million, or 0.49%, bringing the total population to just under 335 million people.

The last official monthly data from Census on births and deaths is from September 2023. However, extrapolating from more recent state data suggests that births likely fell further over the past year to roughly 3.6 million, their lowest level, outside of the pandemic, since 1979. Deaths have, thankfully, fallen from their pandemic highs, and should have declined to 3.1 million in the year ended on June 30, 2024. Still, this would imply just a 500,000 gap between births and deaths which is normally referred to as the “natural” increase in the population.

On top of this natural increase, however, the Census Bureau could report net immigration over the past year of 1.2 million. Total U.S. immigrant visas issued in foreign countries fell from 609,000 in the year ended in June 2023 to 601,000 in the year ended in June 2024. However, looking at border crossings, while there has been some decline in recent months, the numbers are still far above pre-pandemic levels, and total encounters with border patrol agents were up 8% in the year ended in June 2024 compared to a year earlier, at a level of 3.3 million.

It is by no means clear how to translate border crossings into net migration numbers. However, it does seem likely that Census underestimated the growth in net migration in the year ended in June 2023 and may take some steps to remedy this in their estimate for the latest year.

However, even if, under what we think is a conservative estimate, net migration was 1.2 million people and total population growth was therefore 1.7 million over the past year, it would imply a significant demand for new housing units. Moreover, even if migration were to slow dramatically from here, housing demand would likely grow further, as more recent immigrants found employment and became more integrated into the U.S. economy.   

In short, while the natural growth rate of the U.S. population is likely to continue to slow in the years ahead, the recent surge in immigration could boost housing demand for years to come.

Supply: A Need To Build
Second, to the great discomfort of homebuyers but to the advantage of homebuilders and sellers, supply remains very tight.

In June, there were just 1.32 million existing homes for sale—higher than a year ago, but still far below the 1.92 million units that were on the market 5 years ago. A similar picture can be seen in vacancy rates. In the second quarter of this year, the vacancy rate for owned homes was just 0.9% while the vacancy rate for rental properties was just 6.6%, both significantly below their levels of five years ago and far below their average levels over the past 50 years. 

The reality is that many younger homeowners are essentially trapped in the home that they bought a few years ago as they cannot afford to move since it would involve replacing their existing mortgage with something carrying a much higher rate. This is less of a problem for older homeowners who have paid off their mortgages. However, this lack of supply is providing builders with an incentive to build new properties—particularly in areas where population growth is strongest. 

Affordability: A Little Relief On Mortgage Rates
The third key issue for the housing outlook is affordability and here, until very recently, the picture was grim. In June 2019, the monthly mortgage payment on the median-priced existing single-family home was roughly $1,064—with relatively subdued home prices and mortgage rates averaging 3.80%. Five years later, in June of this year, this payment had more than doubled to $2,253, reflecting a 56% increase in median existing home prices and an almost doubling of mortgage rates to an average of 6.92%. Housing affordability effectively got hit with a one-two punch of soaring prices due to post-pandemic scarcity and then aggressive monetary tightening, between March 2022 and July 2023.

While per capita personal income has risen by 28% over the same five-year period, clearly home-ownership has been put out of reach for millions of potential buyers.

That being said, there are some positive signs on affordability in recent economic trends.

• First, recent worries about economic weakness and hopes for Fed rate cuts reduced the average rate on a 30-year fixed-rate mortgage to 6.47% last week—the lowest rate in over a year and more than 1% lower than the cyclical peak of 7.79% seen at the end of October 2023. This drift down in rates should continue in the year ahead as hopes of Fed easing finally become reality.

• Second, strong stock market gains over the past two years have increased the ability of more affluent households to buy new homes in all-cash deals or with larger down-payments, and, 

• Third, while mortgage payments have increased dramatically, so have rents. According to Zillow, the average listed rent on all single and multi-family homes in June was $2,054—up 35% from five years earlier. This, of course, gives renters a powerful incentive to buy a home - if they can just find a way to do so.

The Housing Outlook and Implications
Putting it all together, last week’s drop in mortgage rates obviously came too late to have any positive impact on July’s construction activity and we expect Friday’s report to show a further monthly decline in overall housing starts. However, demographic pressure from recent immigration and a very low supply of properties on the market should support both home prices and rents. In the short run, this should continue to be a good environment for home-sellers and for landlords.

Moreover, as mortgage rates drift down further and potential homebuyers accumulate the resources needed to buy a home, home-building activity should begin to revive. While we expect home-building to still drag on third-quarter economic growth, as has been the case for most of the past three years, by the fourth quarter, activity should begin to rebound and should provide a significant boost to economic activity in 2025, an important positive in an economy still delicately balanced between growth and stagnation.

For investors, in broad terms, it will be important to keep track of housing as a key determinant of whether a soft-landing economy can continue to support both U.S. bonds and stocks. In narrower terms, a potential improvement in housing fundamentals should support both the logic of personal homeownership and investments in housing for rent as part of a real estate portfolio.

David Kelly is chief global strategist at J.P. Morgan Asset Management.