How the Housing Slowdown Impacts the Fed’s Inflation and Economic Targets

  • US home sales fall as Federal Reserve tightens mortgage rates.
  • That has helped moderate inflation, which is now down from a fourteen-year low.
  • But the downturn in the housing market also increases the risk of recession.

Housing may be about to become the Federal Reserve’s policy puzzle.

Market activity has fallen for nine consecutive months and home sales were down 28.4% in October from a year earlier, according to the National Association of Realtors, and some economists warn that prices could fall by 20% next year as a broader recession begins.

While housing prices will need to fall in order to further lower the Consumer Price Index, a dramatic housing crash could also have a negative impact on the economy as a whole. And that will result in a new head of policy for the Fed, which has raised interest rates six times this year to combat price pressures.

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Here’s how the Fed’s monetary tightening campaign has affected the housing market—and why the sector could play a key role in determining whether Chairman Jerome Powell can successfully lower rising rates without triggering a recession.

Why are home sales falling?

The Fed has raised borrowing costs by 75 basis points at each of its four consecutive inflation-fighting meetings.

Financial tightening has increased the average 30-year US mortgage from 5.60% to 6.84% in the past three months, according to Bankrate.

Rising mortgage rates tend to deter potential home buyers because they make mortgages more expensive.

“The slowdown in home buying is one of the things that comes out of monetary policy,” Macquarie chief economist David Doyle told Insider. “Housing is a vulnerable sector to interest rates so it’s no surprise that it has slowed in the current environment.”

What is the Fed saying about the housing market?

So far, the Fed has dismissed any talk that its rate hikes have negatively affected housing.

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

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Still, some central bank economists have called for the Fed to pay more to sell homes and prices as they begin to slow down significantly.

“Fiscal policy must carefully push the needle to lower inflation without triggering a fall in house prices – a significant selloff of housing – which could exacerbate the recession,” said Enrique Martínez-García of the Dallas Fed last week.

How does falling housing prices help the Fed?

The Fed’s top priority now is to reduce inflation, which is still running above its 2% target.

Home prices saw the biggest increase in 34 years of 18.8% last year, according to the S&P CoreLogic Case-Shiller US National Home Price Index – and so the central bank sees deflating the market as a way to bring inflation down. administration.

But October’s CPI print of 7.7% suggested that inflation is now starting to ease, which could give the Fed the margin it needs to start easing its hawkish stance on interest rates.

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As previously stated, we expect unemployment to rise and inflation to decline next year, which could prompt the Fed to ease monetary policy by cutting rates,” said Charlie Dougherty and Patrick Barley. in a recent research article.

Could the slowdown cause a recession?

But the central bank will need to nail down the timing of the policy pivot – because further tightening could slow housing market activity and accelerate a possible recession next year.

Because real estate has a ripple effect on the economy, it generates income for real estate agents, decorators, and other businesses involved in the sales process.

If borrowing costs remain too high for too long, those businesses are at risk of facing a recession at a time when monetary tightening is already squeezing cash flow.

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


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