The Federal Reserve increased short-term interest rates by a quarter-percentage point following the March Federal Open Market Committee (FOMC) meeting, amid the highest inflation rates in more than 40 years.
“We need to move away from very low interest rates,” Fed Chair Jerome Powell said to members of Congress in the weeks prior to the FOMC meeting. “They’re not appropriate for the current situation in the economy.”
He outlined the Fed’s goal of achieving price stability as effectively and efficiently as possible without triggering a recession.
“The committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run,” the FOMC said in a press release after the vote. “With appropriate firming in the stance of monetary policy, the committee expects inflation to return to its 2 percent objective and the labor market to remain strong. In support of these goals, the Committee decided to raise the target range for the federal funds rate to .25 to .50 percent and anticipates that ongoing increases in the target range will be appropriate.”
The Fed also downgraded its forecast for economic growth to 2.8 percent, down from its 4 percent estimate in December, First American Deputy Chief Economist Odeta Kushi said.
“There was a big increase in inflation forecasts; core Personal Consumption Expenditures (PCE) Index is now expected to be 4.1 percent, up from 2.7 percent,” she added. “One of the biggest components of both the Consumer Price Index and PCE is housing.”
Although the Fed rate change doesn’t necessarily directly impact mortgage rates, Kushi said, the Fed’s “quantitative un-easing,” or reduction of its balance sheet, does. The Fed indicated that could be happening as soon as May.
“Quantitative un-easing does place upward pressure on mortgage rates. Mortgage rates have already trended higher in recent months due to a strong economy, higher inflation expectations, and the prospect of Fed tightening,” she said.
History shows that house prices are resistant to rising mortgage rates.
“A look back at six different rising mortgage-rate eras shows that house prices are resistant to rising mortgage rates primarily because homesellers would rather withdraw from the market than sell at lower prices, a phenomenon we refer to as ‘downside sticky,’” Kushi said.
“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,” she said. “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. In the longest rising mortgage rate era, 1998-2000, nominal house prices increased consistently with the economic recovery from the previous recession. In just over a year and a half, house prices increased 14 percent.
“Of course, relative rates matter, and it’s important to highlight that mortgage rates have been in the 2 to 3 percent range throughout most of the pandemic, so an increase to over 4 percent may have a larger impact than in previous rising mortgage rate eras,” Kushi added. “Even so, the housing market will likely remain competitive as an improving labor market with its own supply-demand imbalance results in higher wages, which helps boost house-buying power, and as millennial-driven demand for homes against limited supply of homes for sale continues to push house prices upward.”
One outcome from the rate hike could be a housing market that moves closer to “normal,” Kushi said.
“House price growth continues to remain near record highs, and a severe supply-demand imbalance in the housing market indicates that house prices will continue to grow for the foreseeable future. However, 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,” she said.