The Federal Reserve recently implemented a quarter-percentage-point increase in short-term interest rates to combat inflation, inadvertently affecting the stability of home prices. This move may appear paradoxical, as the Fed is striving to curb inflation. In this article, we explore the consequences of the Federal Reserve’s actions on the housing market and consider whether these measures were indeed necessary.
The Fed’s Interest Rate Increase
The Federal Open Market Committee, a branch of the central bank, raised the federal funds rate to a range of 5.25% to 5.5%. Prior to the meeting, mortgage rates had already risen in anticipation of this rate hike and the possibility of another increase in the near future.
Anticipating the Change
According to Orphe Divounguy, a senior economist for Zillow, investors had anticipated this change and had already factored it into current mortgage rates. Therefore, this Fed rate increase is not expected to directly raise mortgage interest rates any further.
The Necessity of the Fed’s Actions
The Fed has raised short-term interest rates by 5.25 percentage points since March 2022 to combat inflation. Although there has been some progress, with the core consumer price index falling from 6.6% in September to 4.8% in June, it still exceeds the Fed’s target. This prompted the Federal Reserve to raise the federal funds rate once again during its recent meeting.
However, some experts question the necessity of this increase. David M. Dworkin, President and CEO of the National Housing Conference, argues that the increase is unnecessary because it raises the cost of shelter by increasing rates. Shelter costs are a significant driver of inflation, and overzealous rate hikes could lead to undesirable consequences.
Impact on the Housing Market
By increasing interest rates, the Federal Reserve makes borrowing more expensive. Businesses and consumers allocate more of their income to interest payments, leaving less money for other expenditures. The reduced demand is intended to slow down the rise in prices, which has, indeed, been observed.
However, there is an unintended consequence of the Fed’s rapid rate hikes—home prices are not falling as much as anticipated. To understand this, we need to go back to 2020 and 2021 when the COVID recession caused mortgage rates to plummet. Millions of homeowners refinanced at rates below 5%, with some securing loans below 3%.
Following the Fed’s rate hikes, the 30-year mortgage rate now hovers around 7%. This increase has discouraged homeowners from selling their properties, as it would mean accepting higher interest rates. This, in turn, has led to a low supply of homes for sale, causing prices to continue rising, particularly in the Northeast and Midwest.
The ‘Trifecta of Yuckiness’
Carolyn Morganbesser, Assistant Vice President of Mortgage Originations for Affinity Federal Credit Union, aptly describes the combination of higher interest rates, a shortage of homes for sale, and rising prices as “the trifecta of yuckiness.” This situation forces potential homebuyers to consider renting for another year, despite rising rental prices.
Impact on Rental Market
It’s important to note that home prices and rental prices are closely intertwined. As home prices rise, so do rental rates. In June, the median asking rent in the United States was 4.1% higher than the previous year, indicating a slowdown from the pandemic’s peak but still on an upward trajectory.
Orphe Divounguy suggests that the latest quarter-point Fed rate increase, on its own, will not significantly impact home prices. He also expresses hope that mortgage rates might become more favorable in the coming months. The key question now is whether the Federal Reserve will continue raising rates to combat inflation or if they will pause to assess the impact on inflation data.
If the Fed chooses the latter approach, it may signal that the run-up in borrowing costs for homebuyers is near its peak and could begin to decline. Lower mortgage rates would encourage more buyers and sellers to enter the housing market, potentially providing relief to the current housing conundrum.