One housing indicator bodes especially poorly for the economy.

Homebuilder confidence, which gauges the market conditions in the single-family construction space, has plummeted over the past few months as the housing market takes a beating and appears to now be facing recessionary conditions.

“Tighter monetary policy from the Federal Reserve and persistently elevated construction costs have brought on a housing recession,” said National Association of Homebuilders Chief Economist Robert Dietz. “The total volume of single-family starts will post a decline in 2022, the first such decrease since 2011.”

Inflation has rattled the economy, surging to 8.3% as measured by the consumer price index’s latest reading. The too-high inflation has triggered a chain reaction, beginning with the Federal Reserve raising interest rates, that has now filtered down to residential construction through higher mortgage rates.

The construction industry is a good gauge of the overall health of the economy and can be an early indicator of recessions because of how many jobs it supports and how many goods are used in the construction process. Adam Graham is a construction industry analyst at Fixr, a company that specializes in home improvement and remodeling resources. He contends that homebuilder confidence is a crucial metric of the health of different market segments.

The NAHB announced last month that homebuilder confidence has fallen for eight straight months. The NAHB/Wells Fargo housing market index found that builder confidence in the market for newly built single-family homes plunged 6 percentage points this month to fall into negative territory for the first time since a brief period at the start of the pandemic.

About 1 in 5 of the homebuilders surveyed reported slashing prices in the last month to limit cancellations or increase sales, while nearly 70% blamed rising interest rates for declines in housing demand.

“This is a very clear signal from the people who make their money from building homes that we are in or about to enter a housing downturn,” said Graham.

A lot of that dwindling homebuilder confidence is coming from rising mortgage rates. When the Fed raises its interest rate target (which is a different, very short-term rate), mortgage rates also increase. Mortgage rates ballooned over 6% for the first time since the Great Recession this week.

The average 30-year fixed-rate mortgage is now 6.02%, up more than 3.1 percentage points from a year before, according to Freddie Mac. That is a 0.13-point jump in the past week alone.

The Fed has raised rates twice by 75 basis points so far this year. The first hike marked the most aggressive increase since 1994, and it is expected that there will be another jumbo rate hike following the Federal Open Market Committee’s meeting next week, with some investors even betting that the central bank will go a step further and crank rates up by 100 basis points.

When mortgage rates increase, housing becomes less affordable and demand for homes drops. Thus, demand for construction also declines.

Housing starts measure the annualized change in the number of new residential buildings that began construction. Last month, they declined by a hefty 9.6% to a 1.45 million annualized rate after posting slight gains in June, according to a Tuesday report from the Commerce Department.

Additionally, permits to build, which are seen as a proxy for future construction, decreased by 1.3% in July, further adding strain to the housing market.

“Net, net, housing permits have been shrinking every month since the first Fed rate hike in March this year as home builders know what’s-what and which way the winds are blowing,” said Chris Rupkey, the chief economist at FWDBONDS.

“Recession has come to the residential construction markets right on schedule as interest-rate sensitive housing is the first sector to turn down when soaring mortgage rates make it more costly for homebuyers,” he added.

After 2021 marked an explosive year for the housing market because of ultra-low mortgage rates, sales of both existing and new homes have begun to fall off in yet another sign of recession.

Desmond Lachman is a senior fellow at the American Enterprise Institute who has been warning for months that the housing market is in a bubble. He told the Washington Examiner that what economists and homebuilders are seeing right now is that bubble popping.

Sales of existing homes plunged 5.9% in July, marking six consecutive months of declines, according to a report by the National Association of Realtors. Sales are down a colossal 20.2% from a year ago and have accelerated as the year has gone on and the Fed has hiked rates.

Additionally, sales of new homes have tumbled to the lowest level since January 2016. They plunged 12.6% in July to a seasonally adjusted annual rate of 511,000, according to a report from the Census Bureau.

Lachman said the housing market decline portends a recession because its effects ripple out into all parts of the broader economic landscape.

“The housing market is slowing, and as it slows, that spreads to the rest of the economy,” Lachman said. “The builders will get laid off, then they won’t go to restaurants, they won’t buy goods, and so on.”

Reports in the coming weeks on new and existing home sales, as well as homebuilder confidence, will be examined closely to see if the housing and construction downturn is accelerating or is slowing.

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