Lumber prices have defied a cooling housing market to climb 26% in October, but surging mortgage rates will keep a lid on further upside

• Lumber prices have rallied 26% so far in October, but further gains may be limited as the housing market slows down.
• The average 30-year fixed mortgage rate hit 7% in amid the Fed's ongoing rate hike policy.
• "At 7% interest rates, I wouldn't expect lumber to do much for a while," MaterialsXChange's Ashley Boeckholt said.

Lumber prices have staged an impressive rally so far in October, rallying 26% even as the housing market shows further signs of cooling down.

In tandem with the Federal Reserve's aggressive interest rate hikes that started in March of this year, mortgage rates have soared. The average 30-year fixed mortgage rate hit 6.94% on Thursday, according to data from Freddie Mac. That's a marked increase from the sub-4% rate seen right before the Fed embarked on its tightening cycle.

Those higher rates have boxed out a lot of homebuyers from an affordability perspective, with the housing market seeing a consistent decline in monthly home sales. The slow down in the housing market has had a sizable impact on homebuilders, as they delay or cancel projects given the sharp slowdown in demand.

"Abysmal activity across all buyers," one homebuilder said in a recent survey from Zonda's chief economist Ali Wolf. "7% interest rates are crushing housing demand," Wolf said.

The slowdown in housing has spilled over into demand for lumber, according to Ashley Boeckholt, chief revenue officer at lumber trading platform MaterialsXchange. "Building has pulled back and the desire to carry an inventory, at the end use level, is gone," Boeckholt told Insider.

That's in stark contrast to just over a year ago, when lumber demand was so high that futures prices soared to a record of $1,733 per thousand board feet. Today, prices are down 70% to $534 per thousand board feet.

The near 30% rally in lumber prices seen so far in October is likely nothing more than an oversold rally, and it's hard to see lumber futures returning to the high volatility environment it enjoyed throughout 2020 and 2021.

"I think we are seeing a little bounce after a large selloff. At 7% interest rates I wouldn't expect lumber to do much for a while. It is trying to find a trading level above the cost of production. We will still have volatility, but probably not what we've seen the last two years," Boeckholt said.

That's good news for homebuilders, as long as demand returns to the housing market, but one economist is skeptical.

Pantheon Macro's Ian Shepherdson warned that a demand rebound may be far off with home prices set to fall as much as 20%. "Eight straight declines in sales and no floor in sight," Shepherdson said on Thursday. And that plays right into Boeckholt's view of a lumber market that is likely to flatline from here.