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The Fed's Attempt at a Soft Landing Could Fail. Here Are 5 Ways LBM Could Be Affected

By Craig Webb, president, Webb Analytics*

There's growing pessimism that the Federal Reserve can successfully pilot the U.S. economy to a land of lower inflation without any increase in unemployment. Oddsmakers are raising the chances for a recession, though what we're witnessing now is more an expression of nervousness than flat-out certainty. Still, if the pessimists are right, how much could LBM be hurt? That's likely to vary a lot depending on your place in the construction supply landscape. Here are five factors to consider.

If you sell a lot to big builders ...

... watch the tug-of-war between continued demand and higher mortgage rates. In March the seasonally adjusted annual rate for completions of single-family homes was 6.4% below February, while starts were 1.7% below, and permits--the best indicator of future activity--was down 4.8%. All this suggests a slowdown, which is no surprise because many big builders until recently were deliberately limiting their sales. At the same time, note that the annual rate for single-family homes under construction in March was 27.3% higher than the same month last year, while completions were down 3.3% year-over-year. That's a sign that it's taking longer to finish homes.

It's a given that the rise to 5% rates for 30-year mortgage loans will make more homes unaffordable for more people. But Goldman Sachs' Ronny Walker, quoted in Bill McBride's Calculated Risk blog, believes the impact will be felt mainly in the existing home market. As for new homes, "housing starts have historically been unresponsive to changes in mortgage rates in a supply-constrained environment," Walker says. "… That finding supports our strategists’ expectation that housing starts will total 1.7 million this year (a 5% increase vs. 2021).”

If you sell a lot to custom builders ...

... keep an eye out for whether what's under construction is a spec or a build-it-for-me home. Custom homes historically are commissioned by wealthier individuals, so a mild recession might not be too painful unless they were counting on this year's bonuses and stock-market gains to pay for the house. They already have had to swallow hard over all the product price increases of the past two years. A drop in lumber prices actually could make the project more affordable.

Spec builders likely will become rarer, but this will depend in part on geography. Walker believes housing prices will rise 10% this year, even with the economic headwinds. Spec builders in Florida and Texas are likely to have a much easier time than in markets with less overall demand.

If you have a heavy remodeler and DIY customer base ...

... you're most likely to be affected by a recession, which officially is defined as two consecutive quarters of decline in the gross domestic product. A Wall Street Journal analysis of Fed attempts over the last 80 years to lower the inflation rate found that the Fed never has succeeded in cutting inflation by 4 percentage points--its current goal--while avoiding a recession that puts people out of work. The most famous hard landing was in the 1980s, when inflation plummeted from 11.1% to less than 2% but the unemployment nearly doubled to 10.7%. Some of the best soft landings were in the 1990s, but the Journal notes that in none of those cases was the Fed battling interest rates as high as they are now.

Given its daunting task, the Fed lately has been getting only 3-to-2 odds that it will achieve a soft landing. If it fails, you can expect homeowners will postpone or even abandon projects. Pricier K+B work and deck projects could be hurt most, while maintenance jobs and minor improvements won't suffer as much.

If you're based in farm country ...

... a recession is likely to affect you less than how long the war in Ukraine continues. The price of corn is at a nine-year high on the futures markets, and wheat futures on April 18 were 73% higher than on the same date last year. Stock in Deere & Co. is on a 52-week high, partly on expectations that farmers will cash in some of their new-found gains on new tractors. You can expect some also might want to invest in pole barns and homes.

If you sell a lot of sticks ...

... a slowdown could be a good thing. It would make construction more affordable, put less strain on the mills, and reduce volatility. In addition, it's likely that prices will bottom out far higher than the levels they were pre-COVID; there's still all that pent-up demand to consider. Just make certain you manage your margins and costs on the way down.

* -- Before getting involved in construction supply, Craig Webb was an editor at The Wall Street Journal and the chief economics reporter at United Press International.

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