Stagflation woes put California’s housing market on alert

Inflation + stagnation = disaster

What goes up must come down — right?

When people lose jobs, they typically reduce their spending, causing consumer price inflation to drop. But a well-established principle doesn’t always work as expected in the economy — especially when distortions exist in other influential factors.

Stagflation — the toxic blend of long-running high inflation with static economic growth — last occurred here in the U.S. during the 1970s.

However, loose talk of stagflation has increased in the past year, since the Fed began its aggressive fight against inflation, which it has yet to win in 2023 — but will in the near future.

The economy was first sent on the Fed’s collision course with today’s high level of inflation by COVID-19 era supply chain disruptions, which caused prices of goods and services to skyrocket. Similar to the stagflation economy of the 1970s, recent inflationary price disruptions were induced by the extreme fiscal and monetary accommodation policies of the pandemic period of 2020 and 2021, as noted by the Brookings Institution.

Thus, fueled by stimulus checks, Paycheck Protection Program (PPP) business grants, and a quick employment recovery from early 2020 job losses, prices of consumer goods and services — as well as asset prices — rapidly escalated in response to a shortage of things to purchase.

To reduce and correct the high level of consumer inflation, the Federal Reserve (the Fed) raised its short-term benchmark interest rate beginning in March 2022. The Fed sought to rein in borrowing and spending to cool the overheated consumer economy. But its initial rate hikes proved insufficient. As inflation continued to rise, the Fed raised its rates more aggressively, causing consumer inflation to peak at around 9% in June 2022.

Beginning in December 2022, the Fed reduced the size of its rate increases, testing the extent to which they need to raise rates. As justification for what now appears as a lull in Fed rate increases, inflation slipped to a still-high 6.4% as of January 2023, according to the Bureau of Labor Statistics.

Now, after nearly a year of rate hikes, excessive consumer inflation — while weakened — persists, causing many to wonder: will the actions of the Fed necessary to fight inflation cause the economy to cool too much, with the loss of inordinate numbers of jobs, while inflation lingers at today’s repressive heights?

Will stagflation rear its ugly head again in 2023?

The concern for the real estate market

Already, California’s housing market is feeling the crush of recessionary pressures.

With home prices in a freefall and sales volume declining, the seller’s market of the past decade has quickly been turned on its head. The few buyers willing to venture into the market are now in the driver’s seat.

But this is all before the likely job losses anticipated to arrive later in 2023. Once the economy officially enters a recession, California’s buyer-occupants will all but disappear, mortgaged homes acquired in recent years will fall further underwater, and homeowners unable to make their mortgage payments are backed into a corner, forced into foreclosure when they cannot sell.

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Under a stagflation regime, this downward spiral will only worsen.

But with a recession almost certain to arrive in the second half of 2023, stagflation as it is defined is not possible in a recession and thus is avoided. Today, the Fed’s monetary policy is focused on price stability which was not the case in the 1970’s enduring stagflation economy, which ended when the 1980 recession was induced by a change in the leadership at the Fed.

Importantly, and unlike the 1970s, inflation expectations among consumers today remain relatively low, a helpful condition according to economist Paul Krugman.

No matter the size of the economic upheaval already set in motion, real estate agents need to prepare for the slowdown in the real estate markets to continue through 2023, and well beyond.

Real estate agents and mortgage loan originators (MLOs) who wish to maintain a living even as traditional market participants take a step back from acquisitions and home loan originations will learn to innovate, taking on alternative streams of income. Poised to profit off existing contacts in real estate-adjacent careers, these agents will survive and succeed even as the home sales and mortgage market continues to stumble in the years to come.

One situation seems certain; everyone will be more frugal tomorrow.

Expect California home sales volume to continue to slip in 2023-2024, absent brief seasonal mid-year sales bumps. Further, home prices will continue to fall from their mid-2022 peak, likely to bottom around 2025, with a sustainable recovery taking off around 2026-2027.

In the meantime, agents need to pivot from focusing on providing seller services —REO portfolios being the exception — to finding and working with buyer clients and rental property landlords. This means refocusing expertise on the needs of traditional buyer-occupants and investors-in-waiting who purchase at the bottom of the market — the option value of cash and the genetics of deferred gratification realized.

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