A US housing recession has arrived and it could lead to a 20% decline in home prices and Fed interest rate cuts by 2023, chief economist says

James Knightley, chief economist at ING, said that a recession in the US housing market has already begun.

He told clients in a Wednesday note that falling home prices could provide some relief from inflation.

Knightley said that a steep drop in demand for homes has been caused by the high mortgage rates.

The average monthly payment has gone up to over $2,500 a month because of the higher mortgage rates.

This equates to over 40% of the median household income. The typical new annual mortgage payments for a home purchase equates to 26% of median incomes in the fourth quarter of 2019.

Home sale transactions are beginning to show signs of slowing down as mortgage applications are down. As housing starts and building permits surged to 16-year highs at the start of the year, the supply of new homes for sale is likely to increase as well.

Falling demand and rising supply mean home prices are likely to fall. Home price growth decelerated at the fastest pace on record in July, with some of the hottest markets seeing month over month declines.

Knightley said that with more supply coming on the market at a time when demand is weakened, prices will fall further.

With housing valuations looking stretched based on the ratio of existing home prices to median household income, he estimated that home prices would have to fall 20% peak-to-trough for the ratio to return to its long-run average.

The note said that don't expect an imminent housing decline to be like what happened during the financial crisis.

Since their pre-2008 peak, household assets have doubled to $163 trillion. Household liabilities have risen by just $5 trillion over the same period. The percentage of equity that homeowners have in their property is the highest it has been in over 25 years.

Knightley said that the risk of catastrophic loan losses and major strains on the US financial system, even under a scenario of 20%+ price falls, seems small.

As the housing market transitions from a seller's market to a buyer's market for the first time in years, falling home prices are a good thing for first-time home buyers. Falling home prices are a good sign for the Fed as they watch for signs that inflation has peaked.

Knightley said that the Fed wanted a correction. It's important to remember that a housing market downturn will weaken the US growth story, but it will also cause inflation to go up.

If we can see a turning point in the annual rate of change in the key components of the consumer price index, we may be able to bring the US inflation rate back to 2% by the end of 2023. We are firmly of the opinion that interest rate cuts will be on the table in the second half of 2023, even though the Federal Reserve is downplaying the possibility.