Federal Reserve Continues to Push Against Inflation but the Labor Market Is Pushing Back

Two months into the new year, consumers are spending less, economic growth has slowed, the inflation rate has declined (although arguably not as much as the Fed would like), and the over-heated housing market has cooled.

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As the Federal Reserve’s effort to combat inflation has pushed interest rates skyward, housing market signals have turned negative, leading many industry analysts to ask if a housing recession coming and some to suggest that it has already arrived.   

Among the key indicators spurring these concerns:

  • Existing home sales declined for nine consecutive months through October, ending the month almost 30 percent below their latest peak in January of this year.
  • New home sales have been bouncing up and down, but mainly trending down, while home starts and permits for future construction have fallen to their lowest levels in almost two years.  “This is going to be the first calendar year in 11 years where single-family starts will total a smaller volume than the prior year, according to Robert Dietz, chief economist for the National Association of Home Builders, who is predicting a double-digit decline.
  • An NAHB-Wells Fargo Housing Market Index, gauging the outlook for future home sales, fell to 33 on a 100-point scale in October, the lowest level in a decade for this index, on which any reading below 50 is a warning light for the industry. Builders are cutting prices and offering buyer incentives in response.
  • The closely-watched Case-Shiller index, measuring home prices nationally, has declined for three consecutive months – the longest sustained month-over-month dip in ten years. Home prices are still rising overall, but the annual rate of increase fell to 10.6 percent In September compared with the same month in 2021.
  • Rising mortgage rates, scarce inventories and concerns about the economic outlook have sapped consumer confidence in the housing market, pushing a Fannie Mae index of home purchase sentiment to its lowest level in more than 20 years in October. The seller component of this monthly survey has also declined, although not as steeply.

  No Mystery

There is no mystery about the cause of these downward trends:  As the Fed has ratcheted up its benchmark Fed Funds rate, mortgage rates have increased from lows of near 2 percent a year ago to more than  7 percent in October.  Rates have fallen back from that high point, but remain above 6 percent, straining (or breaking) the budgets of many prospective home buyers.  Affordability measures for buyers have fallen to their lowest levels in recent memory. Declining buyer demand has led many sellers to pull their homes from the market or decline listing them in the first place.

Fed officials, who view the overheated (until recently) housing market as a major contributor to inflation, have not been unhappy to see sales and appreciation rates slow.  Although they know  a housing market bust can push the economy into a recession (and has done so in the past), Fed policy makers are currently  more on the labor market, which remains stronger than they would like it to be.  Their concern is that rising prices for consumer goods (and for housing)  will push wages higher, creating a wage-price spiral, igniting inflationary expectations that could become self-fulfilling, making inflation pressures more difficult to control. 

The November employment report did nothing to assuage those concerns. Employers added 263,000 workers to their payrolls, down only slightly from the revised 284,000 October gain that Fed officials viewed as too high.  Wages increased by 5.1 percent year-over year, exceeding October’s 4.9 percent gain, beating analysts’ predictions and deflating Fed hopes for evidence that the labor market is  cooling.

“To have 263,000 jobs added even after policy rates have been raised by some [375] basis points is no joke,”  Seema Shah, chief global strategist at Principal Asset Management, told CNBC.com. “The labor market is hot, hot, hot,” she added, and that is  “heaping pressure on the Fed to continue raising policy rates.”

Slowing the Pace

 Having boosted the Fed Funds rate by three-quarters of a point at four consecutive meetings, Fed Chair Jerome Powell indicated recently  that the Fed might be ready to slow the rate-hiking pace, hoping to slow inflation without tipping the economy into a recession. “if you’re waiting for actual evidence that inflation is coming down, it’s very difficult not to over-tighten,” he told reporters. “We think that slowing down at this point is a good way to balance the risks.”

Powell made those comments two weeks  before the December meeting of the Federal Open Market Committee (FOMC), when the committee, in fact,  voted to increase rates by  just half-a-point, the highest level for this benchmark rate in 15 years. But Powell has also discouraged expectations that the Fed is ready to declare victory in the inflation war, emphasizing both before and after the December FOMC meeting his belief that the Fed has “a long way to go” before price stability is restored and inflation risks sufficiently reduced.   

The link between the Fed’s interest rate policy and the outlook for the housing market is clear. Fed officials have signaled their intention to keep rates elevated this year.  Although some analysts think recent declines in mortgage rates and in the inflation pace might bring earlier rate relief, the consensus view is that the Fed isn’t likely to alter its current course any time soon. 

In a recent interview with DS News, Taylor Marr, deputy chief economist for Redfin News, explained: A slower inflation rate and lower mortgage rates, while welcome, won’t have much impact on the housing market.  [Home sales] and new listings may stop declining” he said,  “but we aren’t likely to see a major boost until there’s more certainty that the Fed’s efforts to curb inflation are working.”