US building permits fell 0.7% in May, reversing part of the prior month’s strength. The latest reading follows a 5.8% rise previously, pointing to a softer pace of permitted construction activity.
The shift from growth to contraction suggests permitting momentum cooled after April’s advance. Building permits are closely watched as a forward indicator for housing supply, capturing intentions to start new residential projects.
Cooling Momentum in Housing Permits and Market Sentiment
Given the sharp reversal in building permits from strong growth to a minor contraction, we see this as a clear signal of a cooling housing market. This report for May suggests that higher borrowing costs are finally beginning to impact future construction plans. We believe this is not a one-off event but the start of a softening trend.
This slowdown is consistent with other recent data points we’ve been tracking. For instance, the National Association of Home Builders/Wells Fargo Housing Market Index has remained below the key level of 50 for several months, signaling pessimism among builders. With 30-year mortgage rates hovering stubbornly above 6.5%, housing affordability continues to be a major headwind for demand.
Strategic Positioning and Broader Economic Implications
In the coming weeks, we will be looking to buy puts on the SPDR S&P Homebuilders ETF (XHB) to position for a downturn in this sector. This provides direct exposure to the companies most affected by a decline in new construction and buyer sentiment. We see this as a high-conviction trade based on this new permits data.
Beyond housing, this data could influence the Federal Reserve’s thinking on interest rates. A slowing construction sector reduces inflationary pressures, making it less likely the Fed will pursue further rate hikes this year. We will monitor interest rate futures for shifts in market expectations for a more neutral or dovish central bank policy.
We have seen this pattern before, such as the slowdown in late 2018 when Fed tightening led to a temporary freeze in the housing market. That period was followed by increased market volatility as investors reassessed economic growth prospects. Therefore, we also advise considering VIX call options as a relatively cheap hedge against a broader market wobble.
Our immediate response is to reduce long exposure to building material suppliers and regional banks with significant mortgage portfolios. We will be closely watching the upcoming Existing Home Sales and New Home Sales reports for further confirmation of this cooling trend. It is time to shift from a pro-cyclical stance to a more defensive one.
