Market Update: Over Fed!

Hi Everyone,

I hope that this update finds you well and still smiling from the Mariner's playoff run (great trade this morning!) and the quick turnaround with the Seahawks!?Shoot, I will even say nice win to you?UW fans?over Oregon.?

The title of this update not only describes my physical well being next Thursday, it also describes my current frustration level with the Federal Reserve.?Let me start with the disclaimer that I am not in the anti-Fed camp, which occupies a lot of chatter on Twitter finance.?The Federal Reserve has served a key role in economic stability?over the years.?I also want to acknowledge?that their job was next to impossible back in March of 2020 given the economic shocks and uncertainty that Covid and Covid protocols?were placing on the economy.?There are no economic models that forecast?the appropriate?level for interest rates and economic stimulus?when?the number of unemployment claims jump by over 20 million in a single month.??

That being said, in February and March of this year it was clear that the housing market was showing signs of overheating.?As discussed in this space, some Covid boomtowns like Boise were seeing annual appreciation rates of up to 40%!?A perfect storm of record low interest rates, record low inventory, and unique housing demand (work from home and needing more space) caused home prices to rise to record levels from coast to coast.?It was time for the Fed to begin backing off their historic accommodative economic policy.?This included their purchases of Mortgage Backed Securities, which are specifically targeted at lowering mortgage rates.?While home prices were soaring to record highs, the Fed was still implementing?policies similar to the Great Financial Crisis and March 2020, when it was clear the housing market no longer needed?any?stimulus or help.?They were throwing gas on the fire.??

Instead, the Fed chose to take a wait and see approach, hoping that inflation was "transitory," which is an academic way of saying temporary.?Let's cross our fingers and hope it just goes away.?Well, anyone that has been to a gas station or grocery store recently knows how that played out.?Temporary turned into the new normal and the Fed missed their window to lower?inflation before?it burned out of control.?In an effort to course correct, the Fed has now had to raise the Fed Funds rate at a historic pace to offset their policy error.?This has led to extreme volatility in many markets, including the housing, stock, and bond markets.??

This past spring, our local housing market was also running at a historic pace, setting price records on a monthly basis.?As mortgage rates began their upward trajectory, we saw a typical buyer behavior?kick in,?the fear of missing out,?on a low mortgage rate.?Demand continued at a brisk pace into May, only to hit a wall once mortgage rates approached 6%.?The summer stock market rally, in part fueled by optimism the Fed would back off their interest rate increases, led to a period of summer buyer?activity.?However, when mortgage rates rose without so much as a pause, from 5.0% to 7.0%, buyer demand decreased significantly.?The decline in demand caused home inventory to rise,?as more and more listings sat on the market.?For example, look at the chart below of Austin (another Covid boomtown) to see how quickly inventory levels have climbed.?The decline in sales is the main reason for the uptick in inventory as the number of brand new listings coming on the market are now declining.?More and more sellers are choosing to sit this one out.??

As sales have declined and inventory has increased, home prices have begun to decline, both locally and nationally.?What started off as a cooling of home prices in an overheated market has now transitioned into a full correction in home prices.?As you can see from the chart below from John Burns RE Consulting, home prices are now falling at a rapid pace.?It's also?very important?to note that prices in 2020 and 2021 rose at a historic rate.?The velocity of price movements both up and down has been a bit dizzying for market participants.?In April, home appraisers were trying to support closing prices that were above any recent sale in a given neighborhood.?Now they are trying to complete reports from current sales that are below most, if not all recent comparables.?The Fed helped drive prices up, now they are making it clear their goal is to cause home prices to fall nationally in an effort to help control inflation.?The analogy has been made that it is like someone holding a gas can and matches in one hand and a fire extinguisher in the other.??

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As 2022 winds to a close, where will the market go in the first quarter of 2023??

That is literally the trillion question. The pace of market activity both nationally and locally will in large part be driven by the Fed.?Market participants wait?to see when the Fed will decide to slow, or even stop their course of interest rate increases.?Even alluding to backing off the size of rate increases alone would cause mortgage rates to fall, likely?back under 6%.?I view 6% as a key level since this is where market activity was most noticeably?impacted.?It's one thing for the Fed to desire overheated housing markets to correct or speculative?stocks and crypto currencies to decline.?It's another thing to raise rates while layoffs are occurring, as we have seen now with local employers Amazon and Facebook.?It's just a matter of time until they pause.?In the nearterm, continued price declines seem almost certain through January given the current momentum and negative buyer sentiment.?At some point, lower home prices and mortgage rates will call buyers back to the market.?Only time will tell when exactly that will occur.??

I wish you and your family and friends a wonderful Thanksgiving!?

All the best,

Steve