What the September Federal Reserve Statement Said:
The Federal Reserve’s rate-setting committee voted unanimously to raise the short-term policy rate by another 75 basis points, to a target range of 3%-3.25%. This marks the highest level for the funds rate since early 2008. Reflecting the economic reality and high inflation, financial markets have been pricing in a small chance that the FOMC would resort to a 100 basis point increase. However, the Fed retained a steady pace, walking the tightrope of tightening without spooking financial markets, which have been expecting today’s move. The Fed also issued its quarterly update to the outlook for the economy and interest rates—the Summary of Economic Projections. The numbers highlight that the central bank expects the economy to retain a moderate level of growth in 2023, even as the unemployment rate moves toward 4.4%. The Fed also expects the target rate to reach 4.6% next year, driving the PCE inflation rate down to 2.8%.
After spending 2021 viewing inflation as “transitory,” the Fed has been playing catch-up this year, running behind fast-paced consumer price growth. Motivated to rein-in inflation running at a 40-year high, and informed by lessons from the 1970-80s, the central bank has taken a hawkish and more aggressive stance in its quantitative tightening. The higher interest rate hikes are being accompanied by simultaneous balance sheet reduction, as the Fed lets Treasury assets and mortgage-backed securities roll off at maturity. Furthermore, the bank’s forward guidance has been unwavering in its messaging over the past few months, with various FOMC members and Chairman Powell indicating that they will not back off from subduing inflation, even at the cost of an economic recession. While theoretically, the recession and rising unemployment are not the Fed’s targets, practically, curtailing strong demand and asset prices will likely lead to an economic recession. The big question is, has the pace and scale of rate hikes been enough to put a dent in inflation over the next 6-12 months?
How Fed Policy Impacts The Economy:
Today’s rate increase will have a quick impact on consumers, particularly for shorter-term borrowing costs. The funds rate serves as a basis for the prime rate, which is used by banks to set interest rates for credit cards, as well as automobile and personal loans. Consumers will see higher rates in the next few weeks. This is expected to have a spillover effect later this year, as we move into the traditional holiday retail season. With higher borrowing costs and incomes that are not keeping up with inflation, consumers may find shrinking shopping budgets, leading to a shorter gift list.
At the same time, rising borrowing costs are impacting businesses that are already being squeezed by inflation and rising labor costs. In addition, with an increasingly likely economic slowdown on the horizon, many companies are moving to contain or cut back on expenses. While layoffs have been limited to certain sectors to date, we may see a growing wave of companies cutting payrolls during this winter.
What the Fed’s Statement Means for Homeowners, Homebuyers and Sellers:
For real estate markets, today’s decision by the Fed means that mortgage rates are expected to continue rising in the coming months. While the Fed’s short-term rate does not directly impact long-term mortgage rates, the trickle-down effect of rising borrowing costs means that homebuyers will continue to feel higher monthly payments. With the rate for a 30-year mortgage 300 basis points higher than last year, the buyer of a median-priced home this week is facing a monthly payment that is 66% higher than the same week in 2021. That’s even before you factor in property taxes, insurance and HOA fees. For most Americans, housing affordability is a critical concern, as home prices and rents continue to rise at double-digit rates and wage growth remains negative, when adjusted for inflation.
The silver lining for housing is that buyers who are still on the market may be seeing price cuts. The sharp pullback in demand has decreased sales of both new and existing homes, and with fewer buyers, sellers are seeing their homes linger longer on the market. As a result, we’re seeing about 20% of properties on the market experiencing price cuts – a level not seen since 2017 when housing markets were on more balanced footing. The transition toward balance is welcome news for many buyers who found the feverish pace of the last two years frustrating. However, the road ahead is likely to remain bumpy, as household finances continue to be squeezed by rising costs and the shortage of homes for sale remains stubbornly in place.