Federal Reserve Holds Rate Steady, But Another Hike is Still on the Table

What the September FOMC Meeting Statement Said:

The Federal Reserve’s Open Market Committee, the rate-setting body that meets roughly eight times per year, voted to hold the short-term policy rate steady at a range of 5.25 to 5.5 percent. Despite rising energy costs, core inflation readings have continued to improve and while the economy is continuing to add jobs, the pace has slowed. Other labor market indicators, including job openings and the unemployment rate, signal a cooling economy. Furthermore, the Fed has already tightened policy significantly, bringing the cumulative monetary restriction in the Fed funds rate to 525 basis points or 5.25 percentage points since the March 2022 liftoff. 

Tighter Policy Holds Back Housing:

With market expectations coalescing around the idea of “tighter for longer” monetary policy, the Fed’s updated outlook offered telling clues. The 2023 year end projection remains at 5.6 percent, meaning that another rate hike before year’s end is not only on the table, it is consistent with the median viewpoint. Further, the expected policy rate needed at the end of 2024 and 2025 is now half a percentage point higher than expected in June. Put another way, the median Fed forecast is consistent with just one 25 basis point rate cut from where we are now by the end of 2024. Fortunately, inflation expectations were little changed. Already, the impact of tighter policy is acutely felt. Mortgage rates have steadied just below recent highs, but remain more than 3 percentage points above their pandemic-era lows. The combined impact of higher rates and higher home prices has driven the cost of financing the typical listed home up more than $400 or 22.5% from a year ago, and up more than $1,100 from August 2020, doubling the cost in three years. 

Higher mortgage rates have radically altered homebuyer purchasing power and have been a key factor in existing home sales dropping from a more than 6.5 million unit pace in early 2022 to the roughly 4 million unit pace in recent months. Perhaps more importantly, higher mortgage rates continue to keep existing homeowners sidelined, with as many as 1 in 7 out of the market because they don’t want to borrow at today’s much higher rates, which are in some cases double their existing cost of funds. As a result, I expect the number of homes for sale to decline this year, and this tension to continue to be a damper on the number of homes for sale and thus home sales transactions. 

Another Hike is Still on the Table

Although the Fed held rates steady, its focus remains fixed on taming inflation and bringing it back to the 2% target. Partly in response to recently higher inflation readings driven by rising energy costs, I expect the Fed to keep the option for an additional future rate hike on the table, which their projections firmly do. In June, the typical Fed member expected that at least one other would be warranted by the end of 2023 but that rates would be a whole percentage point lower than this peak by the end of 2024. This expectation has changed significantly. Fortunately, inflation expectations were not adjusted as much. Monthly inflation readings were on target in June and July and while prices grew faster than needed in August, energy prices were a big driver. Core readings, which exclude more volatile food and energy prices, were much closer to target. The Fed’s projections suggest that the Fed needs to see some additional improvement in inflation before pausing or ending the current tightening and expects to see the Fed funds rate remain above the neutral level all the way until the 2 percent target objective is achieved. 

Shortly, well hear directly from Chair Powell in the press conference. I’m expecting tepid optimism from the Fed, dampened somewhat by recent energy price trends and the Fed’s pledge for vigilance which is likely to be a neutral for mortgage rates in the next few months. I also expect Chair Powell to acknowledge that while housing data continues to be a significant push factor in inflation data, market trends have shifted and will eventually be captured in broader price metrics. In fact, Realtor.com data show that rental listing prices have declined in recent months and rental inflation trends have already reached an inflection point. Recent trends in construction, in which a record number of multi-family homes are under construction despite the dip in starts, suggest that rent softness is likely to continue.