Interest Rates, Real Estate, and the Economy
Americans have overwhelmingly lost faith in the media, and for good reason. Misinformation abounds, and news on the economy is no exception. I am writing today to set the record straight on the relationship between actions by the Federal Reserve and mortgage rates, the local real estate market, and where the economy is likely headed in the coming year.
Nowhere is the disconnect between fact and fiction more apparent than the media narrative regarding the relationship between Federal Reserve policy and mortgage interest rates. The enemy of fixed rate mortgages is inflation. Period. It always has been. Yet the press simply does not seem to get it. The Federal Reserve has only two mandates: “Price stability” of 2% annual inflation and “maximum sustainable employment”, estimated at about 4.1% unemployment. This creates a delicate balancing act as the two objectives often conflict with one another. The tools used by the Fed to “juice” the economy and drive down unemployment tend to boost inflation and the tools used to drive down inflation generally slow the economy and increase unemployment.
According to the press, mortgage rates increase when the Fed raises “rates”. This is simply not true. The Fed controls short-term rates, specifically the Fed Funds Rate, an overnight rate that commercial banks charge each other. The Fed does not control mortgage rates, which are long-term rates. Mortgage rates increase when inflation expectations increase. Inflation is the enemy of mortgage rates. The reason the Fed raises the Fed Funds rate is to curb inflation. From January to June of this year, before the Fed began aggressively raising rates, mortgage rates jumped by nearly 3%. Mortgage rates rose because the Fed underestimated inflationary pressures for nearly a year before acting. Last month the Fed made it clear it (finally) understood the problem and raised the Fed Funds rate by 0.75% while indicating it would likely raise by another 0.75% in late July. Since then, mortgage rates have fallen by about 0.50%, the exact opposite of what was almost universally predicted by the press. If the Fed continues with its anti-inflationary actions, the economy will slow, driving mortgage rates down further. If you obtained a mortgage after March 2022, you will likely be refinancing within the next 12 months.
I am optimistic about the local real estate market going forward. The level of home price appreciation we’ve experienced over the past two years is economically unhealthy and unsustainable. One beneficial side effect of the recent spike in mortgage rates is increased inventory, resulting in more balance between supply and demand. While the market continues to favor sellers, we’re not seeing the degree of craziness we’ve experienced over the past two years. Instead of 12%-15% annual appreciation, we’re likely to return to a more normal 3%-5%. Even if unemployment rises in the coming months, lower mortgage rates, combined with reduced levels of appreciation, will increase housing affordability. Add positive demographic trends to the equation and the outlook for real estate appears favorable.
Finally, is a recession coming, and if so, what will it look like? While few things are inevitable, a recession seems almost certain. Virtually all signals are pointing in that direction, regardless of what the pundits say. The good news is, as recessions go, this one should be relatively mild. Unemployment will be elevated from current ultra-low levels, but not severe. Stocks will rebound quickly once it appears we’ve hit bottom. The U.S. is in a better position than most other countries. Inflation will gradually recede. And local real estate values will hold up well. Don’t believe the doomsayers in the press. Misinformation abounds.