Fed and Housing Market

Answer:  The Federal Reserve Bank (Fed), the central bank of the United States, has a difficult task ahead. The most important objectives of the Fed are: “maximum employment, stable prices, and moderate long-term interest rates in the United States.” The Fed has essentially one tool to accomplish this by adjusting the federal funds rate which is the rate at which commercial banks borrow and lend their excess reserves to each other overnight.

If the Fed sells bonds, then bond buyers buy these bonds removing liquidity from the financial sector. It’s like soaking up spilt milk that, it takes time to absorb the excess. Econ 101 illustrates that with a smaller market of cash, the “cost” or rates to use these funds increase. When the Fed buys bonds, the opposite happens, injecting cash and new liquidity into markets, bringing rates down.

In normal circumstances it generally takes six to 12 months for monetary policy to impact the US economy. The expectation is that the Fed will continue tightening and increase interest rates at the policy meetings in June, July, and September. The expectation is for increases of 50 basis points (0.50%) at each of these meetings. There is a Fed meeting in November, but they seldom increase rates so close to an election. 

If these expectations are true, rates could reach 2.75% - 3.00% by year-end. Anything beyond 2.25% to 2.50% is considered a ‘neutral’ federal funds rate, neither adding nor subtracting from economic activity. Monetary policy depends on data and the behavior of inflation. If inflation remains on a downward trend for the rest of the year on a year-over-year basis, then the Fed will probably not have to increase interest rates in December, and it will remain at a level of 2.25 to 2.50%.

Housing market data suggests that a slowdown has begun in certain areas. Still, the data this week pointed to strong home price appreciation, so more work/time is needed to see the full effects of current tightening. Single family housing starts showed a second monthly decline on a seasonally adjusted basis in April even though it was still higher versus a year earlier. Meanwhile, multi-family housing starts continued to expand, both on a month-over-month basis as well as versus last year.

The median home price in the US is over $400,000, more than double the prices seen at the bottom of the housing bubble over a decade ago. The pandemic seemed to have increased housing demand regions like ours in response to the ‘work-from-home’ trend. 

Coming out of the Great Recession, housing starts were slow to recover and have not kept up with demand. This put further pressure on the supply of available homes, pushing home prices up further. This trend is expected to slow and reverse.

Bottom line: The Fed has a tough job ahead with signs of a slowing housing market have started to appear, and this is good news for the US economy. The housing market slowdown seems to have not affected other sectors of the economy. If this continues to be the case the Fed may be able to engineer the elusive soft landing. Only time, and incoming data, will be able to tell. Stay focused and plan accordingly.