Economists predict home prices will fall, even if the US avoids a recession

• Soaring inflation has led to a slowdown in the US economy, though some measures stay strong.
• The Feds fight against inflationary pressure has greatly weakened housing activity.

There's a strange dynamic happening in the housing market. It could mean home prices will fall in the coming months, even if the US avoids a recession.

That's because as the Federal Reserve continues to raise interest rates, mortgages are getting more expensive. This is causing buyers to pause purchase plans, and home prices are falling as a result.

It's led Cris deRitis, the deputy chief economist at financial services firm Moody's Analytics to project, "Even without a recession and just a slowing of the economy, we already expect home prices to moderate."

His colleague, Mark Zandi, the chief economist at Moody's says price moderation could escalate as the fight against inflation rages on.

"The housing market is the most interest-rate-sensitive sector of the economy," Zandi said in a housing report. "It's on the front lines of the fallout from the Fed's efforts to bring down inflation."

For now, however, even as some cities see price declines, housing costs are still high compared to what most Americans can afford because they are facing mortgage rates that have nearly doubled in the past year. Some economists believe overall costs are at peak and will decline as spring approaches, even as the US job market stays strong and President Joe Biden remains optimistic the country will avoid a recession.

"There's going to be a coast-to-coast downturn in the housing market. It's going to be brutal," Zandi said. "No part of the market is immune."

While the "brutal" downturn might be bad news for real estate investors and people looking to sell, it could be welcome relief for would-be buyers who have been shut out of the market.

Home prices and rents seesaw

With more buyers sitting on the sidelines for now, data published from the S&P Dow Jones Indices shows that price growth turned negative in six major metropolitan areas from April through July, representing a stark shift from last year's home buying frenzy.

During those months, California was home to three of the six cities that saw lower home prices in July compared to just a few months earlier in April. Los Angeles, San Francisco, and San Diego all experienced negative price growth during this period, as well as Seattle, Denver and Portland.

Inflationary pressures have had the opposite impact on rental prices, which continue to climb — although growth is now moderating.

According to rent.com, the US median rental price for a one-bedroom unit came in at $1,721 in August, falling 2.77% from the previous month but up 27.13% from just one year prior. The price of a two-bedroom unit also climbed 23.43% year-over-year to $2,054.

The uptick in rents is helping to worsen economic volatility. Bloomberg reported that the consumer price index — an inflation measure that excludes food and energy — is projected to return to a four-decade high when numbers for September are released on Thursday, partially due to rising rents.

Michael Feroli, the chief US economist at JPMorgan Chase & Co told Bloomberg that although core inflation has likely peaked, housing is helping to keep inflation elevated.

"We're probably near a peak, but that being said, I don't think we're gonna have a speedy return to lower numbers in part because of the persistence of rental inflation," Feroli said.

As rental inflation surges it may result in another large interest-rate hike from the Federal Reserve next month, which could drive up mortgage rates even higher and further escalate the housing downturn — with or without an economic recession.

"The uncertainty and volatility in financial markets is heavily impacting mortgage rates," Sam Khater, the chief economist at Freddie Mac told Insider. In a separate statement, Khater said that "impacted by higher rates, house prices are softening," and home sales are falling.