Several Non-Linear Factors Weighing on Lumber Prices Viewed as Economic Leading Indicator

Lumber prices in many instances can be viewed as a valuable indicator of not only the construction industry, but overall economic sentiment as well as a leading indicator of a “half-year-from-now” economic balance in a given economy.

As we still remember, lumber prices hit a record $1,607 per thousand board feet in May 2021, due to soaring demand for new homes, a boom in DIY home renovation activities, and production and supply chain issues stemming from the pandemic. But about a year later, lumber prices have collapsed, having approached $648, a more than 50% decrease from $1,464 in March.

But this price cycle was a mess for the vital commodity, since high lumber prices in 2020 and 2021 were also an early indicator that construction – and the economy in general – was set to go through some profound inflationary changes. The plummeting price of lumber might be telling us that inflation has peaked. From April 2020 through May 2021, lumber basically led the inflation charts, i.e. history shows that lumber sends signals for the commodities asset class. Lumber’s price dropped before most other commodities corrected and became falling knives in late Q2.

It’s been a wild ride for lumber prices over the past two years, as wood products became one of the most volatile commodities on the market throughout the pandemic.

But rising interest rates have weighed on wood’s price as well, and quite counterintuitively. As we know, the Fed hiked the short-term Fed Funds interest rate by 75 basis points at the June FOMC meeting to 1.50%-1.75%, producing the most aggressive tightening in three decades. All signs point to another 75-basis point hike this month, boosting the rate to 2.25%-2.50%. The Fed is taking on inflation at the risk of igniting a recession, with hopes of a soft landing of the U.S. economy. The central bank is also reducing its swollen balance sheet, allowing previous debt purchases to roll off at maturity, pushing rates higher further out along the yield curve.

As a result, 30-year fixed-rate conventional mortgage rates recently moved from below 3% at the end of 2021 to the 6% level before taking some pause. The rise in mortgage rates puts downside pressure on home prices and chokes the demand for new homes as high prices and rising rates have become roadblocks for many buyers. As the demand for new dwellings declines, lumber requirements fall.

In May 2021, lumber’s annual prices had surged by 300% in response to low supply mixed with high demand for new homes and a boom in home renovation projects. Lumber markets didn’t keep rising predictably, though, seeing a seesaw of soaring prices and sudden plummets.

The first bursting "lumber bubble" occurred last summer – when prices fell 47% in June alone. However, by late last year, lumber prices were observed once again spiking. Homebuilders were looking to secure supply for what looked like a strong 2022 building season. Between August 2021 and January 2022, prices surged from around $400 to over $1,400. But that lumber ascension 2.0 also self-resolved. That sharp episode was unlike the one that occurred in 2021. This time, traders were offloading lumber futures based on fears that spiked interest rates would put downward pressure on housing demand.