Stringent, hawkish, aggressive—all words that accurately describe the Federal Reserve’s continuing strategy to fight inflation. At the Federal Open Market Committee’s latest meeting the group enacted another 75 basis point rate hike bringing the federal funds rate range to 2.25%-2.5%. This was the second straight month the FOMC raised the overnight lending rate by 75 basis points.
This was not unexpected and markets had already priced in this move so there was not a lot of movement after the Fed’s announcement. Fed Chairman Jerome Powell indicated during his press conference that this might be the last intense rate hike for the foreseeable future, saying “As the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases while we assess how our cumulative policy adjustments are affecting the economy and inflation.” The FOMC does not have an August meeting and will reconvene at its annual retreat in Jackson Hole, Wyoming in September.
Meanwhile, the 10- and 2-year Treasury note yields remain inverted and the curve widened out even further after the Fed’s rate hike announcement hitting 32 basis points between the two note yields. Powell said during his press conference that he doesn’t see the current economy in a recession but the yield curve flattening and inversion are strong indicators of recessions. Furthermore, technically speaking, the United States has already slipped into a recession due to a second consecutive quarter of contraction in gross domestic product (GDP). The Bureau of Economic Analysis shows economic growth fell by 0.9% in Q2—there was a 1.6% GDP decline in Q1.
HOUSING INDUSTRY FEELING THE ECONOMIC EFFECTS
Housing ends up getting a lot of the headlines when the Fed changes monetary policy because housing is extremely sensitive to changes in interest rates. Like with most statistics and data, how you interpret them depends a lot on your perspective.
Take for example the latest pending home sales numbers released by the National Association of Realtors. On the surface, you see the headline of a 20% year-over-year drop in the number of signed contracts for existing homes. That headline is a big negative if you are looking at this as a home seller because you’re seeing the demand go down. For potential home buyers, this means that homes could be taking longer to sell. That means there’s potential for increasing inventory and we could be shifting back into a more balanced market instead of the hyper-competitive one we’ve seen over the last two years.
The Commerce Department’s new home sale data tells a similar story. The group’s report shows sales of new homes dropped by 8.1% month-over-month down to 590,000 which is the lowest level since April 2020. The most common reasons cited for the slowdown in demand are higher home prices (due to intense demand and inflated material and labor costs) plus the dramatic rise in interest rates since the beginning of the year.
Again, it’s all about perspective. As this demand decreases, because quite frankly many people are being priced out of the market, economists expect to see home price growth slow considerably. The latest S&P CoreLogic Case Shiller National Home Price Index showed home prices rose at a pace of 19.7% in May. That is still on the high end of home price growth but nearly a full percentage point lower than April’s annual gain of 20.6%.
While that is still a very robust rise in home prices, it’s a second straight month of slowing growth and further moderation is expected. In its latest quarterly forecast, Freddie Mac expects that home price growth will see a precipitous drop off in 2023 moving from 12.8% down to 4% on average. In 2021, home price growth was 17.8% on average according to Freddie Mac’s report.
The other piece of the affordability equation is interest rates. The continued narrative has been just how quickly rates rose from January until now and that is not wrong, but there is another way to look at it. The week of January 6, 2022, Freddie Mac’s 30-year fixed-rate mortgage average was 3.22%. Just three months later, the week of April 14, that average had spiked to 5% before hitting its 2022 peak of 5.81% the week of June 23. That’s an incredibly fast rise which threw a wrench into the secondary mortgage market (which is a big part of why you’re seeing so much turmoil but that’s a separate topic.)
But if you look at it from a different angle, mortgage rates have actually moderated over the last few weeks. Since June’s peak of 5.81%, rates have settled in around 5.5% according to Freddie Mac’s averages. The latest survey for the week of July 28 showed an even lower average rate of 5.3%. Freddie Mac’s economists said in their report that, “Purchase demand continues to tumble as the cumulative impact of higher rates, elevated home prices, increased recession risk, and declining consumer confidence take a toll on homebuyers. It’s clear that over the past two years, the combination of the pandemic, record low mortgage rates, and the opportunity to work remotely spurred greater demand. Now, as the market adjusts to a higher rate environment, we are seeing a period of deflated sales activity until the market normalizes.”