When we take a deep dive into the history of US building permits from 1960 to 2024 as shown in Figure 1 below, a fascinating trend comes into focus. The current level of 1.386 million is not only below the long-term average of 1.436 million, but it's also the lowest since June 2020. This shortfall suggests an intriguing economic lever: could increases in building permits be a secret weapon to invigorate the US economy?

Figure 1: US Building Permits

Increases in building permits generally indicate a rise in housing supply, making them a leading indicator of economic activity. This increase in housing supply brings several economic benefits. Firstly, it can boost employment through more construction projects, thereby reducing unemployment. This translates into higher household incomes, which drive consumer expenditure and, in turn, spur economic growth. Additionally, alleviating housing shortages can lower housing costs, either through reduced rentals or purchase prices. This further boost household incomes and leads to increased spending in other sectors of the economy, driving further growth.


The impact of shelter on inflation can be significant. If the supply of shelter increases and housing costs decrease, inflationary pressures may ease. Conversely, if housing costs rise, they can contribute to higher inflation. Therefore, changes in shelter supply as indicated by changes in building permits need to be closely monitored. Increases in building permits tend to reduce the cost of shelter, thus pulling down inflation. However, this effect could be partially offset by increased consumer expenditure resulting from higher household incomes. Nevertheless, households tend to save a portion of increased income, which moderates the impact on inflation.


Movements in inflation may signal central banks to act as they are mandated to maintain price stability – moderating inflation. Decreases in shelter costs pull down an economy’s inflation rate. As shown in Figure 2 below, shelter consistently makes up more than 30% of the US Consumer Price Index (CPI). Therefore, lower inflation may be an indicator of a slowdown in economic growth. This could prompt central banks, such as the US Federal Reserve Bank (The Fed), to cut interest rates to stimulate economic growth. This will be assessed against the offsetting effect of increased household expenditure from higher household incomes.

 

Figure 2: US CPI Components

Since the COVID-19 pandemic, monetary policy has been a predominant driver of market behaviour. Low interest rates have had a profound impact on financial markets, particularly equities and fixed-income securities. Tech stocks, in particular, experienced substantial gains as low borrowing costs supported growth and innovation. However, the expectation of rising inflation has led to concerns about future interest rate hikes. Since then, significant rate hikes have put a strain on household incomes, which could result in catastrophic events such as job losses and an economic recession.


2024 began with high expectations for aggressive interest rate cuts. These expectations were soon tapered as The Fed opted for a more conservative approach, closely monitoring economic indicators, including inflation and employment rates. Given the significant weight of shelter costs in the US CPI, as illustrated in Figure 2 above, understanding trends in building permits can provide valuable insights into future monetary policy decisions.


Monetary policy changes have a direct impact on both equity and fixed-income markets. For equities, lower interest rates generally lead to higher valuations because borrowing costs decrease and corporate profits may increase, resulting in higher stock prices. Additionally, increases in consumer spending boost company earnings, thus pushing share prices up. In the fixed-income market, an inverse relationship between interest rates and bond prices exist – when interest rates rise, bond prices fall, and vice versa. This relationship is crucial for investors to understand, especially those holding long-term bonds, as changes in interest rates can significantly impact their portfolio values.


Changes in the US economy influence other markets, and South Africa is no exception. Changes in US monetary policies affect South African investors. Increases in building permits, which could ultimately lead to The Fed cutting interest rates, might spur the South African Reserve Bank (SARB) into action in their own rate-cutting regime due to the potential adverse effects on the local currency. This could ultimately boost the South African financial markets and economy.


Building permits in the US are more than just an administrative measure; they are a key economic indicator with far-reaching implications. By closely monitoring trends in building permits, investors can gain insights into the future supply of shelter, inflation trends, and potential monetary policy actions. This knowledge can inform investment strategies in both equity and fixed-income markets, helping investors navigate the uncertainties of 2024 and beyond. Understanding the ripple effects of US monetary policy on global markets, including South Africa, can further refine investment strategies and enhance returns.

 

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