How the housing slowdown affects the Fed’s inflation and economic targets

  • US home sales continue their decline as Federal Reserve tightening pushes up mortgage rates.
  • That has helped dampen inflation, which is now retreating from its highest levels in four decades.
  • But a slowdown in the housing market also increases the risk of a recession.

Housing may well become a major policy puzzle for the Federal Reserve.

Market activity has fallen for nine straight months and home sales were down 28.4% in October from a year earlier, according to the National Association of Realtors, with some economists warning that prices could fall 20% next year if the broader delay starts.

While house prices will have to fall somewhat to keep overall consumer price index inflation in check, a dramatic real estate crash could also have a knock-on effect on the economy as a whole. And that would give the Fed, which has raised interest rates six times this year to counter price pressures, new policy headaches.

Here’s how the Fed’s monetary tightening campaign has impacted the housing market — and why the industry could play a key role in determining whether Chairman Jerome Powell manages to bring skyrocketing prices down without triggering a recession.

Why are home sales falling?

The Fed has raised borrowing costs by 75 basis points at each of its last four consecutive meetings to fight inflation.

Aggressive monetary tightening pushed the average 30-year mortgage rate in the US from 5.60% to 6.84% over the past three months, according to Bankrate.

Rising mortgage rates deter potential home buyers because they make home loans more expensive.

“A decline in home sales is one of the by-products of tighter monetary policy,” David Doyle, Macquarie’s head of economics, told Insider. “Housing is an interest rate sensitive industry, so it is no surprise that it has slowed significantly in the current context.”

What has the Fed said about the housing market?

So far, the Fed has brushed aside any comment that its rate hikes would have had a negative effect on the housing market.

Powell said last month the market “should go through a correction” after a combination of pandemic-era fiscal stimulus and tight supply fueled a housing bubble last year.

Still, some central bank economists have called on the Fed to pay more attention to home sales and prices as they begin to slow significantly.

“Monetary policy must proceed cautiously to bring inflation down without triggering a downward spiral in home prices – a significant home sell-off – that could exacerbate an economic downturn,” said Enrique Martínez-García of the Dallas Fed. week.

How do falling home prices help the Fed?

The Fed’s main priority right now is to tame inflation, which is still well above the 2% target.

According to the S&P CoreLogic Case-Shiller US National Home Price Index, home prices rose 18.8% last year, the strongest in 34 years. check.

But October’s CPI pressure of 7.7% suggested that inflation is now starting to slow down, which could give the Fed some room to temper its aggressive stance on interest rates.

As mentioned earlier, we expect unemployment to rise and inflation to ease over the course of next year, which should most likely prompt the Fed to reverse course and ease monetary policy by cutting interest rates Wells Fargo economists Charlie Dougherty and Patrick Barley said. in a recent research paper.

Could the slowdown trigger a recession?

But the central bank will have to determine the timing of such a policy shift, as too tight a policy could curb housing market activity and accelerate a possible recession next year.

That’s because housing has a multiplier effect on the economy, generating revenue for realtors, interior decorators and other industries involved in the sales process.

If borrowing costs remain too high for too long, those industries risk facing a decline in sales at a time when monetary tightening is already straining their cash flows.

“Ultimately, this should spill over and begin to affect job growth and the labor market,” Macquarie’s Doyle told Insider. “This is partly why we expect a recession in 2023.”

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