It seems the housing market is making clear what it needs to cool down: higher mortgage rates.
The strength in the housing market is an unwelcome development in the Federal Reserve’s fight to lower inflation to 2%. Fed Chairman Jerome Powell spoke last year about the need for a ”reset” in the housing market. To the extent the Fed’s tweaking of interest rates is meant to help balance the market, the evidence so far in 2023 is that a rate of 6% is too low. To keep the economy from overheating, mortgage rates around 6.5% — their closing level on Friday — get closer to the mark.
This is a sobering reality, once again exposing the tension between the need to provide affordable, adequate housing options for people, and the Fed’s goal to stabilize prices around a target of 2% inflation.
It’s not hard to argue that current trends are inconsistent with 2% inflation. The economy added more than 500,000 jobs in January. The unemployment rate fell to 3.4%, a 50-year low. Home and auto sales appear to have surged. After some revisions to the data, we now know that inflation as measured by the Consumer Price Index ran hotter in the fourth quarter of 2022 than previously known, rising at an annualized rate of 4.3% in December. If inflation decelerated to 4% at the end of 2022 and then economic growth accelerated at the start of 2023, it’s hard to see the path back to 2%.
That’s probably going to require tighter financial conditions in the form of higher interest rates. We’ve already seen markets re-price to reflect the strong jobs report. Ten-year treasury rates rose by 0.35% between the release of the January job numbers and last Friday’s close. Thirty-year mortgage rates rose even more, to 6.5% from 6%.
That should help to prevent the economy from overheating in 2023, but try telling that to a would-be homebuyer who’s been struggling with affordability issues for the past year. Just as they were on the cusp of affording a home as mortgage rates eased toward 6%, rates are shooting up again.
The question is what stops this frustrating cycle. Early last year the jump in mortgage rates to 5% cooled off the housing market. In December I anticipated that, given rising incomes and modest declines in home prices, 6% mortgage rates would stabilize the housing market. It turns out I was too optimistic.
Achieving the warm-but-not-hot balance the Fed wants to keep inflation inside its target range is going to take at least 6.5%. As long as the labor market remains resilient, any reduction in home buying brought on by higher mortgage rates just leads to more pent up demand driving up prices in the future. By the second half of the year, maybe 7% mortgage rates will be the level needed to keep the housing market from running away again.
We’ve still got to assume that raising interest rates will eventually cool the economy enough to weaken the labor market, rein in inflation and relieve some of the pressure on housing. But right now, it appears that rates may need to go higher — perhaps much higher — than appreciated only a couple of months ago. Where is the tipping point? Until we find it, don’t expect conditions to get any easier for homebuyers. The Fed believes it can’t allow it.
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Conor Sen is a Bloomberg Opinion columnist. He is founder of Peachtree Creek Investments.
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