Speaker: You're listening to the Economics and Country Risk Podcast from IHS Markit. In each episode, our experts will provide you with a clear 360 degree perspective on what's happening around the world.
John Anton: Hello, this is John Anton with IHS Markit’s pricing and purchasing team. I'm hosting a podcast today with Deni Koenhemsi who is the lumber analyst here with the pricing and purchasing team. And looking at the pricing and the availability and it is they’re in turmoil. There are several markets that are really tight and really high priced steel, plastics, lumber and microprocessors. And they're all under very strong pressure but for different reasons. Today, I'm going to talk to Deni about why lumber is expensive, is there going to be relief, and what perhaps the risk would be of things not going well? Deni, can you discuss lumber prices? They're making headlines in the United States are so high. Where do prices stand right now?
Deni Koenhemsi: Thank you, John. Yes, the softwood lumber prices continue to make headlines in the United States, and they are at a record high right now. The daily futures prices in the Chicago Mercantile Exchange broke that $1,000 per 1000 board feet in early April. In addition, prices have been hovering around that price for most of the 2021 so far. This is an incredibly high price. It is four times as high and the low point at the onset of the pandemic. It is close to three times higher than the average long-term annual pricing. So, it is we're sort of stuck around the record pricing right now.
John Anton: So, three times higher, so it's around $1000, and normally, it's around what about $300, $350?
Deni Koenhemsi: Right around that range. $300 and $350 is where you would expect lumber prices to be at normally. Obviously, ups and downs, but we're nowhere close.
John Anton: That's a truly incredible price increase. And that's actually bigger than we've seen in most things such as steel and plastic. So, those are extreme, but yours is even bigger. What's driving the increase in prices?
Deni Koenhemsi: It’s supply and demand mismatch that we at pricing and purchasing are all too familiar with due to the effects of COVID-19 pandemic. As you say, we see them in steel, we see them in plastics, semiconductors, even shipping rates, right to name a few of them. And of course, then softwood lumber used in housing construction specifically is one of those commodities. With a lot of the commodities we cover, we focus a lot on the supply and everyone talking about right now supply shortages. We have these disturbances to the supply chain. But I'd like to note that despite the downtime and reduced production during spring 2020, the softwood lumber supply in the United States has actually increased compared to 2019 levels. So, 2020 production wise, wasn't a bad year per se. And now when we look at the latest releases, the major producers have highlighted their production to be back at pre pandemic level. So, they are working at full capacity here. Yes, there are disruptions still to weather or transportation, but overall supply has increased last year.
So, really at this point, we need to look at a little bit more on the demand side. And that's what I would like to highlight. They were various dynamics that resulted in a 12% increase in single family housing starts in 2020, which is the main driver of lumber prices and almost an equally strong spending on the home improvement side, the two main drivers of the softwood lumber prices in North America. So, you've seen and very big jump in demand. And why is that, right? People were stuck at home, they needed more space, right, which led to home improvement. Those who still have jobs, they couldn't go on vacation or any of the outings they typically do. They had the disposable income, they diverted that their spending to their homes, right, building more equity in their homes. Again, home improvement, again, lumber.
There was this pent up demand after the recession that was getting slowly released. And it ended up with wind in its sails as some realized, again, mortgage rates were low. Again, they needed their space. So, they bought homes, right? The existing home inventory was very tight, and it got tighter, which meant more homes needed to be built. So, you get this multiple increase, you know, supports right here from people who are stuck at home to people who needed space who needed to move up to a new house at this point. So, while demand increased at this phenomenal rate, supply didn’t. Yes, it did increase, but it didn't increase at this phenomenal rate.
John Anton: So, essentially, if you looked at supply and look back at pre pandemic, it would be fine. But demand is much higher than pre pandemic. And so even though supply at first glance is good, demand is higher. So, we need more supply now than we did pre pandemic, is that correct?
Deni Koenhemsi: We definitely need more supply. If the demand continues that way, the way that we've seen, we definitely need more supply. But the way we are looking at it right now is that the adjustment to pricing is really going to come from a lower demand profile instead of a significant uptake in supply.
John Anton: Change in pricing, does that mean improvement from the buyer point of view?
Deni Koenhemsi: Yes, we do see that eventually, eventually, that demand is going to slow down, which will mean that supply will be able to catch up. We did have periods in 2020, right around fall, where we've seen evidence of that, right? Supply did catch up and we did see prices going down. But now when we look in the first months of 2021, that demand is still going very strong, right? And supply just has not had that level of increase yet.
John Anton: Deni, the present is really bad. If you are a home builder or someone looking to buy a house and facing the high lumber prices, where do we go from here? Should we get used to this high level, is it the new normal or what is your trajectory for prices?
Deni Koenhemsi: So, John, I do expect prices to improve over the second half of 2021. We are at a very high point here in April. And we don't expect a dramatic correction initially because spring and summer are traditionally the high demand months for lumber. The weather is nice, people can keep building. Because we don't see a very sharp reversal in demand and we do not see new mills coming online and increasing production dramatically, we can't really say prices will collapse anytime soon. But we do expect that slowly but surely over the third in the fourth quarter, prices will begin to correct.
There's several dynamics that's going to slow that pace of demand and allow supply to catch up, which will mean lower prices. And it's really that reversal of dynamics that we've talked about earlier, and that we're sort of so special support cases, right, for higher demand and lumber. So, right now in the United States, increasingly more people are getting vaccines and they're getting out more. So, that disposable income that was getting spent on people's houses for improvement will now be spent on vacations and eating out all these activities that people did not get a chance to do for more than a year now. This will mean that segment that spurred that demand for home improvement will not be there anymore, right? That disposable income has gone somewhere else.
New home construction, right, that was another leading demand factor. And it has some impediments for that at this point. So, lumber prices that have been so high for a couple of months now is taking a toll on home builders. There's been estimates of these high lumber costs adding up to $25,000 to the cost of building a home. And just to put it in perspective, here, the median home price in the United States in the first quarter was close to $300,000. It's a pretty big increase. So, that is certainly a big impediment on new home construction. So, not only the prices are high, but builders are also can't get to lumber, which also prevents more homebuilding. Another factor mortgage rates, right, they are starting to go up albeit slowly, but that trend is expected to continue. This coupled with the fact that home prices, which soared last year, continue to grow double digits year on year in the first half of the year in 2021.
So, there are many factors, right, from mortgage rates to high prices, both in the commodities, to the home prices itself, that is going to take that steam off of demand where people say, “Hold off, I'm not going to be able to buy that home anymore. This is too expensive.” Or people are going to say, “Well, I haven't been on a vacation for more than a year. I'm going to spend my money on that.” So, as a result, HIS Markit macroeconomists forecast housing starts to drop in the third and the fourth quarter. And this slowing in demand will result in supply to catch up and then prices to get slowly down to the levels that we're used to seeing. But I do want to emphasize that it is going to happen slowly over a period of time. That demand is not going to be sucked away all of a sudden, but it will dissipate.
John Anton: So, Deni, when you say that price declines won't come rapidly, are we looking for really to decline to start in the third quarter or is it more fourth quarter and early 2022 before we see significant declines? And two, when do you believe it’ll get back down to under $400?
Deni Koenhemsi: We do expect prices to come down in the third quarter starting in the third quarter, as we sort of close the construction season here in North America. So, we definitely do see that supply catching up. With regards to coming down below $400, I do not see that happening in 2021.
John Anton: So, it will improve, but it will still be higher than what people would be expecting based on 2019 and 2018.
Deni Koenhemsi: Correct.
John Anton: Okay. What about any other commodities in home construction has seen this type of rise? Is there anything else that created the same pressure?
Deni Koenhemsi: Definitely, there's two other commodities that we'd like, you know, we can highlight here. And plywood would be one of them, again, used in single family construction very heavily. Oriented strand board also another commodity that's used in home construction heavily is seeing quite a bit of tightness and dramatic price increases that you see in softwood lumber as well. So, there are a few other commodities. And when you look at overall commodities that are used in single family home construction, a basket of them shall we say, you can say that, at this point, prices are about 10% or so higher compared to last year. And this is a big basket. It involves all sorts of products that's used in home construction. But that sort of gives you a perspective of the price increases that home builders are facing right now.
John Anton: So, what about other parts of the world? We know it's bad in North America. What about Europe or Asia or any other region, is anyone else facing the same dynamics?
Deni Koenhemsi: Certainly, we do see price increases for lumber across the world, but I can definitely say that the increase that we see in North America is quite a bit higher than the increase, let's say that we see in Germany, and or the increases that we see in China or Japan and Korea. So, they are seeing increases, it's just not at the level that we have here in North America. And that can be tied to really, again, the demand environment in North America is doing significantly better compared to some other parts of the world who are recovering from pandemic or experiencing pandemic in different ways.
John Anton: So, thank you, Deni, and it's very good information on lumber and homes building cost. As I said at the beginning, there are other reasons materials that are also in bad supply or high pricing including microprocessors, steel and plastics are some of the most prominent. And much of the problem for those was rooted in COVID, but now as we move into 2021, and hopefully the world moves past COVID, there have been some other issues such as mill outages, bad weather, ships stuck sideways in the Suez Canal. So, supply chains are under pressure, there will be more to this to come. And to keep up with the issues, we would invite you to regularly tune in, and hopefully provide you with good information on where supply and prices are going. Thank you.
Speaker: Thank you for listening to the Economics and Country Risk Podcast from IHS Markit. Connect with us on Twitter at economics risk, and don't forget to sign up for our newsletter at ihsmarkit.com/ecr.