Think of this as ‘number of new houses being built’. Put like that, you can see that this is more about the confidence of housebuilders than it is about the decisions of homebuyers. Of course, housebuilders will tend to have more confidence if they expect more demand for housing, but that is an indirect reflection of consumer confidence. Housing starts more directly reflects business confidence.
Given the capital and labour resources involved with the building of a house, housing is often one of the first industries to turn down ahead of a recession. It’s worth bearing in mind, however, that every recession is different, something very apparent in the most recent pandemic-induced recession. In recessions that are particularly unusual, such as that in 2020, leading indicators can’t typically be relied upon.
In ‘normal’ recessions, however, the slowdown in economic activity reflects the natural business cycle. Just before a slowdown and recession, interest rates are normally high as a result of inflationary pressure causing central banks to raise rates. Since the building and purchase of a house rely heavily on borrowing, high interest rates can trigger a slowdown in the housing sector before other sectors, making data on new housing starts a leading indicator of broader economic activity.
Similarly, in the depths of a recession, labour is abundant, interest rates are low, and many prospective homebuyers are just coming to the realisation that they’ve made it through the recession with their jobs intact. On the way back up, therefore, the housebuilding sector is one of the first to signal a recovery.
A related indicator – released at the same time as housing starts – may be even more leading as an indicator of economic activity. This is new building permits. New building permits reflect approved applications for breaking ground on new residential property. A permit naturally comes before construction starts, so observing data on permits can give you a lead on identifying when and where new building might occur. However, the permit itself doesn’t add to economic activity, and some permits never result in actual building happening, so it may be a less tangible indicator.
Strong housing starts data tends to be good for equities and bad for bonds as it reflects positively business cycle activity. However, as with many other indicators, look out for overheating, by observing capacity utilisation and inflation measures. Signs of inflation running too hot may trigger a tightening of monetary conditions by the central bank, slowing activity and leading to equity losses. The dollar would then likely be supported as short-term interest rates begin to rise, while the US yield curve would likely flatten or invert as investors seek the safety of bonds.
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