Wharton’s Susan Wachter talks with Wharton Business Daily on SiriusXM about the contradictory forces affecting the housing market.

The Federal Reserve raised benchmark interest rates by 75 basis points last week in its latest attempt to curb inflation, which is still above 8% despite dropping gas prices. The move also pushed up the mortgage interest rate to nearly 7%, tightening the grip on potential homebuyers who are already squeezed by a real estate market offering historically high prices across the country. Wharton real estate and finance professor Susan Wachter joined Wharton Business Daily on SiriusXM to explain the contradictory forces acting on the housing market and how the market is affected by the wider economy. Housing prices eventually will fall, she said, but not without a significant rise in unemployment.

Wachter is also co-director of the Penn Institute for Urban Research and an advisory committee member of the Bureau of Economic Analysis of the Department of Commerce.

Listen to the podcast above, or keep reading for edited excerpts from Wachter’s interview, which is based on her commentary that appeared recently in Barron’s.

On the Fed’s Fiscal Strategy:

The purpose of raising the basis points, of course, is to slow down the hot market, to get the reset that Chairman [Jerome] Powell is talking about. But in the short run, it has a countervailing, unintended effect of locking in more homeowners. Ninety percent of mortgage holders are below 5% interest, and two-thirds have mortgages below 4%. They are not going to sell to borrow at 6.3% for a new home. So, we’re seeing inventory not increasing and still way too low for a supply-demand balance. Housing prices are not falling. In many markets, they’re rising. In some of the hottest markets, we’re seeing stalling and slight slowdown. But in the U.S. as a whole, housing prices are still rising and therefore rents are, too. We’re in an ironic position here, unfortunately, where the CPI (Consumer Price Index) continues to rise despite the Fed’s actions, because of housing.

“The construction industry is in a recession. But if you own your home or are looking to buy a home, it’s not in a recession for you.”— Susan Wachter

On the Supply-demand Imbalance:

We haven’t really seen this combination of demand-supply outcomes where the construction industry is clearly in a recession, single-family housing starts are down, and construction firms are badly hurting. But the overall housing market, when you look at prices, is not in a recession. Powell is waiting for that reset, but it’s not upon us yet.

The construction industry is in a recession. But if you own your home or are looking to buy a home, it’s not in a recession for you. Housing prices are not falling, rents are not falling. Rents are rising at a 10% rate, and this is by no means what a recession looks like. The median house price is down, but that’s down in part because of the composition of sales. It’s down over the month, but over the year it’s still up nearly 7%, 8%. It’s a very unusual, confusing combination of different forces going on right now. This will change if we’re in a recession in the overall economy — then housing prices will decline, but we’re not there yet.

On Whether House Prices Will Fall:

Historically, except for the Great Recession, housing prices have never fallen except with a substantial rise in unemployment. So that’s where, unfortunately, the economy is going.

The affordability factors are driving potential homeowners into the rental market. We see no sign of that abating. Quite the contrary. As mortgage rates rise, and we see future rises as the Fed continues to tighten — which is likely — that’s just going to drive more folks to the rental market and force rents up.

“The U.S. cannot afford protracted, high overall interest rates, so the Fed really has no choice but to be stalwart in its stance of controlling inflation.”— Susan Wachter

On Whether Mortgage Rates Will Fall:

That’s the question of when and if we get inflation under control. If and when we do, mortgage rates will settle down again. There are people who are buying. We have nondiscretionary homebuyers out there while existing sales are down. We still have homebuyers, people who need to move from that rental for reasons of new children or a new job or more space. It’s happening in part because demographics are pushing that. The largest cohort is at that age — 32 to 36 — where buying a home is at the highest rate. We also have investors buying homes and converting them to rental properties. The motivation is out there. Why? Because housing is an inflation hedge. It’s the tried-and-true inflation hedge.

The end result is that as the Fed continues to constrain money supply and raise rates, at some point the overall economy will turn. We will have a recession, and inflation will come under control. At that point, mortgage rates will drop. The good news is for those who must buy now, the 30-year fixed rate mortgage has optionality to refinance. That’s the silver lining for an unfortunate turn of the economy, which hopefully will see a slowdown as opposed to a recession.

On the State of the Economy:

We are going to see mortgage rates fall. How many months, how many years, we don’t know. I don’t think anybody knows. I don’t think the Fed knows. There’s just tremendous uncertainty in the market right now. But we will see rates come back down because we have to see overall inflation and interest rates come down. The U.S. cannot afford protracted, high overall interest rates, so the Fed really has no choice but to be stalwart in its stance of controlling inflation.