Inflation, The Housing Market and The Federal Reserve

The Federal Reserve is stuck between a rock and a hard place. They are tasked with stomping out decades-high inflation without sending the economy into a recession. One of the biggest issues with that, however, is the red hot housing market. As the market continues to remain hot, in terms of price appreciation, time-on-market, and inventory, raising mortgage rates might be the only solution to solve the market frenzy. However, because of inflation and hot money, the market may not cool itself fast enough.

With rising rates and increasing home prices working together to price out certain buyers and slow sales, the dysfunctionality of the real estate market might be ending. However, with so much pent up demand over the past two years, coupled with the lack of supply of houses, home prices are still accelerating upwards. Because of a lack of housing supply, a rise in mortgage rates over the next 12-18 months may not have the same impact on new-home-builds as it did before. This is creating a dilemma over inflation, the housing market and the Federal Reserve itself.

The Federal Reserve and Rates

As everyone has heard by now, the Federal Reserve raised their Fed Funds Rate for the first time since 2018 last month. This move is seen to stomp out inflation, even as most experts project that the Federal Reserve is far behind. Higher interest rates allows for the market to slow due to increased costs-to-borrow. As monthly payments increase due to housing prices and mortgage rates, there is thought that mortgage rates will lead to the slowdown we need. However, rising costs boost construction of new homes, and can impact consumer spending and wealth.

As the housing market remains hot, even after the uptick in mortgage rates, the Federal Reserve is going to be stuck acting aggressively. They are increasing borrowing costs even higher, as prices will take months to years to react to slight increases. According to Mark Zandi, chief economist for Moody’s Analytics, “They’re not going to get the decline in economic activity through housing that they typically get, at least not as quickly as they typically get it, they may have to press on the brakes even harder.”

The Great Increase In Rates

Federal Reserve Chair Jerome Powell and his colleagues are looking to raise rates by the most in a single meeting since October of 2000. They look to raise rates by 50 basis points on Wednesday and are looking to reach a consensus rate of 2.5% by the end of December 2022. While this rate is not the same as your mortgage rates, the Federal Reserve does impact your mortgage rate indirectly. However, even raising these rates will not look to decrease inflation towards the 2% long-term target.

The housing market looks to be the thing to watch in terms of deciding if the Federal Reserve has done enough to lower inflation. Fed officials have talked multiple times since their first rate increase in March. Several of these officials are pointing towards the mortgage rates as a sign that whatever their guidance has been has already had an impact on housing. However, most studies and actual data we have seen have not shown that mortgage rates have impacted demand.

Housing Data

According to existing home sales, which account for close to about 90% of all of the U.S. housing market, sales have fallen 2.7% in March, the lowest level since June 2020. This data comes from NAR (The National Association Of Realtors), which is the one organization that you should actually trust when reading about housing data. According to CPI data, housing increased 4% in a year from March to March. However, according to NAR, home prices increased by 20% year-over-year.

Distinguishing whether buyer demand and competition will slowly ease and how home prices will react based on rates or seasonality is going to be tough. Most of this comes down to what we will see in terms of housing supply, which continues to hover near record lows. Because of soaring inputs costs, supply-chain snafus, and difficult hiring conditions, the housing market continues to be dysfunctional. We have seen a hesitancy in builders since the last housing bubble and recession. This contributes to the lack of supply, as we are still below historical rates of new builds.