Fed raises rates by a quarter percentage point, 25 basis points
The Federal Reserve on Wednesday approved its first interest rate increase since 2018 in an effort to stem inflation while preserving economic growth. Mortgage Professional America reached out to an economist to explain the implications of the move.
The Federal Open Market Committee said it would raise rates by a quarter percentage point, or 25 basis points. Odeta Kushi (pictured), deputy chief economist at First American Financial Corp., broke down the development.
“As expected, the Fed raised rates by 25-basis points, and penciled in six more this year,” she told MPA. “Fed officials downgraded their forecast for economic growth to 2.8%, down from their 4% estimate in December, while there was a big increase in inflation forecasts – core Personal Consumption Expenditures (PCE) Index now expected to be 4.1%, up from 2.7%.”
The federal funds rate set by the central bank represents the interest rate at which banks borrow and lend to one another overnight.
“One of the biggest components of both the Consumer Price Index and PCE is housing,” Kushi told MPA. “Due to how the housing components of inflation are measured, they tend to lag the observed rental and house price increases by approximately one year. It’s just beginning to show up in official estimates and will keep overall inflation elevated.”
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The Fed also indicated balance sheet reduction is on the horizon, possibly as soon as May. Kushi said this also has implications for the housing market “While changes to the Federal Funds rate may not directly impact mortgage rates, ‘quantitative un-easing’ does place upward pressure on mortgage rates,” Kushi noted.
The move comes at a time when mortgage rates had already been on the rise, she added. “Mortgage rates have already been increasing for many reasons - improving economy, higher inflation expectations and Fed tightening. As rates rise, some buyers on the margin will pull back from the market and sellers will adjust price expectations, resulting in a moderation in house price appreciation.”
Also affected: “The other implication of a rising mortgage rate environment is the rate lock-in effect,” Kushi said. “Many homeowners have locked into historically low rates, and are less likely to move as rates move higher - this does not bode well for housing supply.”
Notwithstanding the rate hike, Kushi said house price growth continues to remain near record highs. A severe supply-demand imbalance in the housing market indicates that house prices will continue to grow for the foreseeable future, she added. However, she added, as rates do rise, affordability may become an issue for some buyers on the margin. As buyers pull back from the market and sellers adjust their price expectations, house prices will likely moderate.
“A look back at six different rising mortgage-rate eras shows that house prices are resistant to rising mortgage rates primarily because home sellers would rather withdraw from the market than sell at lower prices – a phenomenon we refer to as ‘downside sticky’,” she said.
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She added that apart from the 1994 rising-rate period, when house prices declined slightly and briefly, house prices have always continued to rise, albeit more slowly, when rates have increased. Similarly, in the 2005-2006 housing bubble, house prices eventually declined after initially increasing, but never declined below the level at the beginning of the rising-rate era, she added.
“In the longest rising mortgage rate era, 1998-2000, nominal house prices increased consistently with the economic recovery from the previous recession,” Kushi said. “In just over a year and a half, house prices increased 14%.
“Of course, relative rates matter, and it’s important to highlight that mortgage rates have been in the 2-3% range throughout most of the pandemic, so an increase to over 4% may have a larger impact than in previous rising mortgage rate eras,” she added.
Still, the housing market will likely remain competitive as an improving labor market with its own supply-demand imbalance results in higher wages, the economist said, “…which helps boost house-buying power as millennial-driven demand for homes against limited supply of homes for sale continues to push house prices upward.”
One possible outcome from rising rates: “A market that moves closer to equilibrium, with less price appreciation than last year,” Kushi concluded.
