Moody's Chief Economist Mark Zandi issued a stark warning on Monday, declaring a "red flare" now signals danger in the US housing market. As both consumer good and investment asset, residential real estate influences household spending through wealth effects within America's economic machinery. Moody's cautioned that a severe housing downturn could suppress consumption, constrict construction activity, weaken bank balance sheets, and trigger credit contraction—potentially driving the economy toward significant deceleration or recession.

The "red flare" terminology specifically warns of emerging vulnerabilities: plunging home sales, rising contract cancellations, persistently high interest rates, buyer retreat, and deteriorating seller prospects. "Unless long-term mortgage rates fall substantially from their near-7% historic highs soon," Zandi stated via social media platform X, "home sales, construction, and prices will remain in a sluggish state. Unfortunately, this seems unlikely near-term."

Earlier this year, Zandi had signaled only a "yellow flare" for the sector despite political and economic tensions. His Monday upgrade to "red flare" status reflects deteriorating conditions: "Sales have plummeted to extremely low levels. Builders sustained transactions through interest rate buydowns and price cuts, but they're abandoning these costly measures." He highlighted builders deferring land acquisitions as a critical indicator, predicting imminent declines in new home sales, construction starts, and completions.

ResiClub and Realtor.com data reveal surging inventories in specific markets: Austin-Round Rock-San Marcos, Texas (70% annual increase), Denver-Aurora-Centennial, Colorado (58%), and Memphis, Tennessee (51%).

Zandi further warned that housing could soon become a "full headwind" to broader economic growth. "Home price appreciation has held up well, but momentum is fading. Prices are flattening and will decline," he noted. With demand stagnating under 7% rates, financially constrained homeowners face relocation challenges: "Demographics and employment necessitate moves to higher-opportunity cities, yet households have limited capacity to accommodate such transitions under current financing conditions."

Housing construction, transactions, and financing constitute 15-18% of US GDP, employing millions while supporting local governments and consumer spending via wealth effects. Historical patterns—particularly the 2007-09 subprime crisis—demonstrate how severe housing contractions weaken consumption, shrink construction, impair bank health, and spark credit crunches. However, only deep price collapses coinciding with demand destruction, excessive leverage, and financial instability trigger recessions; moderate adjustments typically function as economic "speed bumps" rather than "crash points."

The sector's dual role as economic pillar and barometer means deep, leveraged price crashes combined with demand collapse almost invariably cause recessions. Yet milder corrections don't necessarily induce economic contraction—outcomes depend on price decline severity, household debt levels, banking resilience, and policy response speed.

Why do US mortgage rates hover near 7%? The answer lies with the 10-year Treasury yield—the "anchor of global asset pricing." Despite the Federal Reserve cutting rates by 100 basis points since last September to a 4.25-4.5% federal funds target range, 30-year fixed mortgage rates remain elevated due to persistently high term premiums in long-dated Treasuries.

Thirty-year mortgage rates typically track 10-year Treasury yields with a 1-2 percentage point spread, reflecting similar durations, investor benchmarks, and mortgage-backed security (MBS) pricing models. Unlike overnight interbank rates affecting short-term funding, fixed-rate mortgages originate as MBS—priced against 10-year Treasuries by bond investors evaluating comparable duration returns.

The rate formula reveals: 10-year Treasury yield = expected short-term rates + term premium. Mortgage rate = 10-year yield + "secondary spread" (covering MBS-Treasury differentials for prepayment/credit/liquidity risk, plus primary-secondary spreads for underwriting costs and lender profits). Meaningful rate relief requires both declining long-term yields and recovering MBS demand.

Goldman Sachs has turned pessimistic, slashing its 2025 US home price forecast to 0.5% growth (down from April's 3.2% projection) and 2026 to 1.2% (from 1.9%). The bank cites three headwinds: substantial price cooling, rising supply, and enduring high mortgage rates. With expanding budget deficits potentially locking term premiums at 4.2-4.5%, Goldman now expects average 30-year mortgage rates of 6.5-6.75% through 2025. The widening gap between 7% borrowing costs and income growth is finally suppressing housing demand and prices—reversing the inflation-era trend where real estate served as a "last bastion" of stability. Instead, the sector now threatens to become a "potential drag" on economic momentum under triple pressures: restrictive rates, supply-demand rebalancing, and MBS illiquidity.