Fed Policy & Housing: where do we stand?

Let’s review the recent key events driving the financial and housing markets. It’s critical to understand the context leading up to these events and the sequence of these events to gain insight into what the future may hold.

For months, the Federal Reserve has been raising interest rates aggressively to combat extraordinary inflation. Prior to December, the central bank had raised the Federal Funds rate, their central interest rate tool, from zero to 4.00%. This rapid approach creates disruptions to the economic sectors most closely tied to interest rates, namely housing and construction.

The graph below shows the 30-year mortgage rate rising rapidly from below 3.0% to over 7.0% in 2022.

This raised the price of buying a home and reduced the affordability of housing overall. The National Association of Realtors Housing Affordability Index has fallen from a peak of 2020 169.9 to an October 2022 low of 91.2. Since 2020, home prices have risen rapidly (over 30% yoy in Phoenix, Austin, and Miami), but today prices haven’t declined enough to offset the rise in the cost of money. It truly is the worst of both worlds for home buyers.

Median sale price has only begun recently to slow as the median days on the market has risen, reflecting the drop in affordability to home buyers. Despite the rapid increase in the 30-year mortgage, Redfin data shows home prices are still 5% above last year.

This lack of affordability shows up in survey data on buyers who are looking to move. As I’ve been referencing over the last 2 months, the survey data from Mayflower 2022 “Finding Home” study showed that inflation was the leading theme across the for future and past movers. In fact, 91% said the cost of living is their biggest concern with 84% saying affordable housing is next. 57% said they were going to cut back on their discretionary spending due to inflation with 46% expecting a recession to last 2-3 years. What’s interesting about this Mayflower survey, is that it predicted one of the key economic indicators, retail sales.

What happened during the week of December 12th-December 16th?

The first big data point of this week came on December 13th with the release of the November US consumer price index data. It was 7.1% versus expectations of 7.3% with the core CPI (ex. food and energy) rising 6%. While improving, CPI is still extraordinarily high and negatively impacting workers and families. The graph below shows the decline from 9.0% in June.

This drop in CPI fueled hopes that the Federal Reserve would end its rate hike cycle sooner than expected and ease monetary conditions sometime in 2023. Stock prices rose rapidly on this date and bond yields declined.

On December 14th, the central bank met to decide interest rate policy. The Federal Reserve raised short-term interest rates by 50 basis points as expected. This was not a surprise to the markets as the board members had for weeks been telegraphing this move, essentially telling them exactly what to expect. However, markets anticipated Chairman Jay Powell would address the declining CPI inflation data and give an indication of ending the current rate hike cycle.

Sadly, this didn’t occur as Powell indicated that not only would rates continue to go higher but that they would stay higher for longer. This sent stocks sharply lower as the markets reassessed this new information and priced it into their earnings models.

On December 15th, the economic data showed the worst of both worlds for stocks and home buyers. First, US retail sales sank in November by a surprise 0.6%, the fastest decline all year. (This was predicted by the October Mayflower survey mentioned above.) This means the Fed’s interest rate hikes along with higher prices are curbing spending decisions. Secondly, US jobless claims fell indicating a firm job market. This means Fed policy still has a long way to go to ease inflation as companies appear to still be hiring, workers continue to get wage increases (See pilots and railroad workers), and inflation is likely to stay elevated. The stock market fell both on 12/15 and on 12/16 because of this bad news is bad news and good news is bad news data.

For housing, this means a longer period of relatively higher interest rates and poor affordability. This level of affordability is why NAR’s Chief Economist Lawrence Yun believes home sales will fall 6.8% in 2023. ?

The good news is that the 30-year mortgage appears to have peaked at 7.08%. Using the same chart from above, it shows a drop of about 50 basis points to 6.5% since the peak.

However, this is a relatively small decline and won’t make a dramatic change in home buyers’ behavior. And the Federal Reserve has told us that they won’t be easing conditions any time soon over the next year. All of this leads to a challenging seller’s market with home values under pressure until prices come down to help offset the rise in the cost of money and improve affordability.?