The surge in new home sales looks strong–but supply, demand, and interest rate gravity tell a different story.
KEY TAKEAWAYS
New home sales surged 20.5% due to builder discounts
Pandemic-era supply and demand shifts drove prices higher
Inventory has improved but prices remain elevated
Discounts boost demand temporarily but don’t solve affordability
Lower rates will fuel demand faster than supply can respond
NEXT UP
Housing affordability is not coming back through falling prices
Builder discounts are a short-term trick, not a long-term fix
The Fed can move rates, but can’t defy supply-demand gravity
Lower mortgage rates will make prices higher, not lower
John Mayer explains economics better than most policymakers
You can quote me: “Affordability won’t come from falling prices. It’ll come from rising incomes and supply growth.”
Gravity. “Stay the hell away from me,” exclaimed John Mayer in his 2006 superhit. He laments about that which he cannot control. While he was referring to the pressures of life, his musings could also be relevant in the exciting world of economics. What? You don’t find economics exciting? I get it, but I do, and it is my job to interpret it and present it to you in a way that is… well, maybe a little more exciting.
First of all, in case you hadn’t noticed, I am not a fan of free markets. I am a believer in what economists refer to as market primacy in which prices, competition, and voluntary exchange are the mechanisms which allocate resources most effectively. In other words, government intervention should be very limited allowing market forces to get things done. This is sometimes referred to as Chicago School Economics and is also closely associated with economist (and fellow Rutgers alumni) Milton Friedman. Though he favored what is known as Monetarism, which involves government control of the money supply, market forces are expected to do the rest of the heavy lifting.
One of the most common market forces involves supply and demand. I talk about it often in my writings and videos, often referring to it as Econ 101. Supply and demand set the stage; prices call the shots. When demand runs hot or supply runs thin, prices move, nudging buyers and sellers back toward balance. Let me be clearer, declines in demand or increases in supply push prices lower, while increases in demand and decreases in supply push prices higher. The latter is the process which dictates the overarching narrative of the past several years: inflation. A big part of that came in the housing market–which I am sure, did not escape you.
Yesterday, the US Census Bureau reported a monthly 20.5% surge in New Home Sales. Economists were expecting a slight decline for a second straight month. If you follow this stuff closely, you will know that a move like that is… … HUGE, and rare. If you don’t follow it closely, I will tell you that it is huge and rare. The reason for the surge was likely aggressive price incentives given by homebuilders. This statement, alone, implies that supply and demand forces are at work.
Remember when prices go down (discounts), we buy more stuff, generally speaking. That is why the demand curve is downward facing. We will get back to that in a minute, but first we need to step back and figure out how the economic gravity got us to where we are in the housing market–a very messy situation.
During the pandemic, the housing market went into overdrive as the demand curve shifted sharply outward (to the right). Record-low mortgage rates, stimulus-boosted incomes, and the new reality of “work from home” sent buyers scrambling for homes at nearly any price. Kind of at the same time, the supply curve shifted inward (to the left) as lumber prices soared, labor grew scarce, and supply chains clogged up, leaving builders with higher costs and fewer completions. The cocktail of surging demand and tightening supply pushed equilibrium prices much higher, while volumes failed to keep pace. In other words, cheap money pulled buyers in, expensive costs pushed builders out, and together they made housing one of the most inflated markets of the post-COVID era.
This chart shows single family house inventory across US regions since mid-2022. Don’t worry about the actual units, but do note how inventory, or supply, declined across all regions (even the bouncing Northeast) as the Fed raised rates and inflation skyrocketed. But we can also note how inventories returned to and even exceeded COVID-era levels.
Since 2023, the picture has shifted as the supply curve edged outward even though mortgage rates stayed elevated. Builders adapted to earlier cost pressures, helped by easing lumber prices, smoother supply chains, and policy incentives, bringing more inventory online. That additional supply created a new equilibrium with more homes available, softening the upward pressure but keeping prices high relative to pre-pandemic norms. Basically, supply caught up just enough to cool the frenzy without pushing prices down. The result is a housing market still expensive, but less suffocating than it was at the peak.
Because prices remained unnaturally high, builders more recently have been forced to sweeten the deal with incentives like deep discounts. In terms of supply and demand curves, these incentives act like a temporary outward shift in demand where buyers see the same sticker price but effectively pay less, which pulls more of them into the market. That outward shift in the demand curve creates a new equilibrium point where more homes are sold but at a lower effective price than the headline number suggests. The supply curve itself hasn’t moved in this step, but what changed was buyers’ willingness to meet the price once discounts bridged the gap. The outcome is higher sales volumes and a housing market that looks strong on paper, even if the underlying affordability story is still stretched. SO, what happens next–gravity, of course.
The surge in demand sparked by builder discounts has obviously worked in the short run, based on yesterday’s numbers. More homes are moving, and inventories are being cleared. But incentives don’t come free, and unless construction ramps up further, the higher sales pace risks crashing into the limited future supply. That could mean builders will eventually scale back projects, nudging the supply curve inward again just as discounts wear off. If demand stays firm while supply tightens, equilibrium prices could push even higher, leaving affordability stretched all over again. In other words, incentives may buy time, but without real supply growth, the market risks snapping back to the same old problem, which is too many buyers chasing too few homes. 🫤
Of course, the real wild card still remains… interest rates–THE hot topic of the day. 😉 A meaningful drop in mortgage rates would shift the demand curve outward as sidelined buyers rush back in, while also giving builders some relief on financing costs that could expand supply. The trouble is that demand tends to react much faster than supply, which means the immediate effect of lower rates is usually higher prices, not cheaper homes. In that sense, lower rates don’t fix affordability, they just reshuffle the deck and move the market to a new, hotter equilibrium. The path forward still hinges on whether builders can keep pace with the buyers who come storming back once borrowing costs fall.
That makes the chances of housing prices truly coming down in the future… well, a long shot. Lower mortgage rates will almost certainly unleash more demand quickly, while new supply takes years to come online. Unless there’s a shock that breaks demand (like a recession 🤮) or a policy shift that floods the market with new construction, affordability won’t improve through falling prices. Instead, what is more likely is that prices will stay elevated while incomes slowly grind higher and incentives like discounts fill the gap. In other words, lower rates don’t reset the housing market, they just change the terms of entry for those trying to get in.
So, before we start celebrating the return of the housing market, we need to take a step back and understand what is really happening with the basic forces of economics. Also, while lower mortgage rates will certainly have what appears to be a positive impact on the market, the longer-run result will include higher prices because of those same economic forces. Folks, you simply can’t avoid gravity. According to John Mayer, “twice as much ain’t twice as good, and can’t sustain like one half could, it’s wanting more that’s gonna send me to my knees!” Mayer is not an economist, but a super talented blues man… who seems to completely understand the power of market forces.
YESTERDAY’S MARKETS
Stocks gave up ground yesterday as traders took a well-deserved breather ahead of today’s and tomorrow’s economic releases. Even bulls need a break from time to time. 10-year yields resumed their march higher steepening the yield curve.
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Annualized Quarterly GDP (Q2) is expected to come in at 3.3% in line with the prior estimate.
Durable Goods Orders (August) may have slipped by -0.3% after declining by -2.8% in July.
Initial Jobless Claims (September 20th) is expected to come in at 233k, slightly above last week’s 231k claims.
Existing Home Sales (August) probably declined by -1.5% after climbing by 2.0% in the prior period.
Fed speakers today include: Miran, Goolsbee, Williams, Schmid, Bowman, Barr, Logan, and Daly. Wow, that’s a lot of hot air–make sure you have a sharp pencil handy.