House prices may climb further – but slide next year if mortgage rates stay at 8%, says top strategist

• US house prices may climb even higher by the end of this year, Morgan Stanley's Jim Egan says.
• However, they could fall by 5% in 2024 if mortgage rates don't drop and transactions are flat, he says.

US home prices might climb even higher by Christmas, but they could slump next year if mortgage rates don't fall, a top-flight housing strategist says.

National house prices jumped by 5.3% to a record high in the first seven months of this year, according to the S&P CoreLogic Case-Shiller Index. A recent pullback in supply could push them upward in the weeks ahead.

"We do think in the very short term that provides a little bit of upward pressure on home prices," said James Egan, Morgan Stanley's co-head of securitized research, on a recent episode of Bloomberg's "Odd Lots" podcast.

While his team's base case is that prices remain flat for the rest of the year, they're moving toward their bull case of a 5% increase, he said.

However, the investment bank's models indicate that if housing supply grows by just 5% next year, mortgage rates don't come down, and sales and transaction volumes remain flat, then home prices could fall by 5%in 2024, Egan said.

Mortgage rates have surged from about 3% to 8% in under two years, which has led prospective sellers who've locked in cheap, fixed-rate mortgages to balk at listing their homes. There's also been insufficient homebuilding over the last 15 years, leading to a shortfall of as many as 6 million homes, Egan said on the podcast. Those two trends mean there's a shortage of homes for sale.

At the same time, the jump in mortgage rates has priced out many buyers who aren't willing or able to pay top dollar for their next home and take on onerously large monthly payments.

"We're dealing with kind of a big headwind and a big tailwind at the same time," Egan said, referring to the pressures on housing supply and demand. He expects mortgage rates to come down by the middle of next year, and prices to come under pressure if they don't.

"Over the medium term, if rates stay at these levels, we think the demand will remain pretty tepid, which means that we are reliant upon supply remaining near historic lows to keep home prices at these levels," Egan said.

Egan added that steep mortgage rates also weigh on housing starts, and can have wider impacts on the economy because people spend less money buying homes and preparing their homes for sale.

Mortgage rates have jumped largely because the Federal Reserve has raised its benchmark interest rates from virtually zero to more than 5% since last spring. The central bank has raised borrowing costs to combat inflation, which hit a 40-year high of over 9% last summer, but has slowed to below 4% in recent months.