Federal Reserve Accelerates Rate Hikes


To fight persistent inflation, the Federal Reserve has committed to significantly cooling demand. This approach reflects a non-monetary policy failure to fix underlying supply-side challenges that are pushing up inflation. The Fed lacks policy tools to make these supply-side fixes, so it must rely on demand-side impacts to bring down inflation by reducing economic growth. Consequently, at the conclusion of its June meeting, the Fed raised the federal funds target rate by 75 basis points, increasing that target to an upper bound of 1.75%. This is the largest increase for the funds rate since 1994 and is a clear response to elevated inflation data from May. Moreover, the Fed’s forward-looking projections indicate on a median participant basis an additional 205 basis points of tightening through 2023. Without convincing evidence of moderating inflation, the Fed is likely to continue to raise the target rate at each meeting by 50 basis points or more. The Fed’s target is a 2% inflation rate. The Fed’s June statement also confirmed its existing plan to reduce its balance sheet, including net reduction of $35 billion of mortgage-backed securities a month when fully phased in. The lack of change for the balance sheet reduction plan is a positive element of today’s news for housing, as there was a risk of a planned faster pace, which would further increase mortgage interest rates. Given signs of slowing economic activity, including six straight months of declines for home builder sentiment, a clear risk is that by falling behind the curve, the Fed will overshoot on tightening and bring on a recession as it fights inflation. This would not be the soft landing the Fed is attempting to orchestrate. Indeed, the NAHB economic forecast now includes a 2023 recession as financial conditions tighten. Chair Powell noted in his press conference that housing market conditions are slowing given higher mortgage rates. The Fed notes that inflation remains elevated, citing the Ukraine war and global supply-chain issues, among other factors. Their revised economic projections find slowing economic growth, with a GDP outlook for 2023 of 1.7%. This will be very difficult to achieve. The Fed’s unemployment projection sees that rate increasing to 4.1% through 2024.  So even under this optimistic outlook, this increase for joblessness would qualify as a growth recession. As this economic slowing occurs, the Fed’s projections indicates inflation will decline. Using the core PCE measure, the Fed sees a 4.3% rate for 2022, then 2.7% in 2023 and falling to 2.3% in 2024. This too will be difficult to achieve given the lagged impact on inflation from increasing residential rents, which materialize in inflation readings on a lagged basis when leases are renewed. This shelter impact on inflation is also a reminder that tightening interest rate conditions can affect supply, not just demand. Higher rents are due to a lack of housing supply. And higher interest rates will make it difficult to finance the development of additional housing supply. It is important to note that there is not a direct connection between federal fund rate hikes and changes in long-term interest rates. During the last tightening cycle, the federal funds target rate increased from November 2015 (with a top rate of just 0.25%) to November 2018 (2.5%), a 225 basis point expansion. However, during this time mortgage interest rates increased by a proportionately smaller amount, rising from approximately 3.9% to just under 4.9%. Previously, the Fed noted that inflation is elevated due to “supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures.” While this verbiage may incorporate policy failures that have affected aggregate supply and demand, I do think the Fed should explicitly acknowledge the role fiscal, trade and regulatory policy is having on the economy and inflation as well. Given today’s projections, we reiterate our policy recommendation with respect to any possibility of a soft landing. Clearly, elevated inflation readings call for a normalization of monetary policy, particularly as the economy moves beyond covid-related impacts. However, fiscal and regulatory must complement monetary policy as part of this adjustment. Yet, many of these measures are simply beyond the Fed’s control. For example, higher inflation in housing is due to a lack of rental and for-sale inventory and cost growth for building materials, lots and labor. Higher interest rates will not produce more lumber. A smaller balance sheet will not increase the production of appliances and materials. In short, while the Fed can cool the demand-side of the economy (reducing inflation and growth), additional output on the supply-side is required in order to tame the growth in costs that we see in housing and other sectors of the economy. And efficient regulatory policy in particular can help achieve this goal and fight inflation. Related ‹ Weakening Builder Confidence Points to Economic Troubles AheadTags: economics, FOMC, home building, housing, inflation, interest rates, single-family

Federal Reserve Accelerates Rate Hikes2022-06-15T14:15:41-05:00

Inflation Hits a Fresh 40-Year High in May


Consumer prices accelerated again in May as shelter, energy and food prices continued to surge at the fastest pace in decades. This marked the third straight month for inflation above an 8% rate and was the largest year-over-year gain since December 1981. Both energy and shelter index recorded their largest annual gains since September 2005 and February 1991. This persistent inflation is likely to push the Federal Reserve to continue tightening monetary policy and raise rates at an accelerated pace. The Bureau of Labor Statistics (BLS) reported that the Consumer Price Index (CPI) rose by 1.0% in May on a seasonally adjusted basis, following an increase of 0.3% in March. Excluding the volatile food and energy components, the “core” CPI increased by 0.6% in May, the same increase as in April. In May, the indexes for gasoline, shelter, and food were the largest contributors to the increase in the headline CPI. After declining 2.7% in April, the energy index rose by 3.9% in May with the gasoline and natural gas index rising 4.1% and 8.0%, the largest monthly increase in natural gas index since October 2005. Meanwhile, the food index rose by 1.2% as the food at home index rose 1.4 percent. Other major component indexes also continued to rise in May. The indexes for shelter (+0.6%), airline fares (+12.6%), used cars and trucks (1.8%) and new vehicles (1.0%) showed sizeable monthly increases in May. The increase in shelter index was the largest monthly increase since March 2004. The index for shelter, which makes up more than 40% of the “core” CPI, rose by 0.6% in May. The indexes for owners’ equivalent rent (OER) and rent of primary residence (RPR) both increased by 0.6% over the month. Monthly increases in OER have averaged 0.5% over the last three months. More cost increases are coming from this category, which will add to inflationary forces in the months ahead. During the past twelve months, on a not seasonally adjusted basis, the CPI rose by 8.6% in May, following an 8.3% increase in April. The “core” CPI increased by 6.0% over the past twelve months, following a 6.2% increase in April. The food index rose by 10.1%, the first increase of 10 percent or more since March 1981, and the energy index climbed by 34.6% over the past twelve months. NAHB constructs a “real” rent index to indicate whether inflation in rents is faster or slower than overall inflation. It provides insight into the supply and demand conditions for rental housing. When inflation in rents is rising faster (slower) than overall inflation, the real rent index rises (declines). The real rent index is calculated by dividing the price index for rent by the core CPI (to exclude the volatile food and energy components). The Real Rent Index remained unchanged in May. Over the first five months of 2022, the monthly change of the Real Rent Index stayed virtually unchanged, on average. Related ‹ The Aging Housing StockTags: cpi, inflation

Inflation Hits a Fresh 40-Year High in May2022-06-10T10:18:59-05:00

Large Metro Suburban Single-family Construction Slows


By Litic Murali on June 7, 2022 • Recent developments in the first quarter of 2022 per NAHB’s Home Building Geography Index (HBGI), indicate single-family home building slowing in suburbs, with most other regional geographies following suit. Following the aftermath of COVID-19, home buyer preferences for the suburbs have eased. Supply-chain challenges and unfavorable economic conditions have reduced the pace of single-family residential construction across all regional submarkets. The effect was most pronounced in high-cost areas such as large metro suburban counties, with growth decreasing from 18.7% in the first quarter of 2021 to 5.2% in the first quarter of 2022. Large metro core counties by contrast experienced the smallest growth reduction for that period, a 0.7 percentage point decline to 8.8%. Micro counties were the only submarket to post an increase in the growth rate from the first quarter of 2021, a 3.9 percentage point increase to 16.7%. Rampant inflation, one of the economic problems in the first quarter of 2022, has driven up material costs but even when adjusted for inflation, they set a record high at the end of 2021. Market share changes also reflected the slowdown of large metro suburban counties’ single-family construction. On a four-quarter moving average, year-over year basis, large metro suburban counties’ single-family construction’s market share dropped from the first quarter of 2021 by 1.3 percentage points to 24.8%. Large metro core counties’ market share dropped by 0.3 percentage points to 16.6%. All other regions, which can be grouped as “lower-density submarkets”, captured the above market share decreases. Large metro areas’ outlying counties’ market share increased the most, by 0.5 percentage points to 9.6% and non-metro, non-micro counties increased the least, by 0.1 percentage points to 4.2%. It deserves noting that the latter category has historically maintained this market share, only wavering by 0.1 percentage points downward in most quarters. An upcoming post of this HBGI iteration will identify the first quarter trends in multifamily home building. Related ‹ How a Home Purchase Boosts Consumer SpendingTags: construction materials cost, HBGI, home building geography index, home buyer preferences, inflation, market share, Material Costs, nonmetro, regional differences, single-family construction, suburban, supply chains

Large Metro Suburban Single-family Construction Slows2022-06-07T09:18:22-05:00

Consumer Credit Increases in First Quarter


By Litic Murali on May 9, 2022 • In the first quarter of 2022, non-real estate secured consumer credit, per the Federal Reserve’s latest G.19 Consumer Credit report, grew at a seasonal adjusted annual rate of 9.7%, with revolving debt growing at 21.4% and nonrevolving at 6.1%. Total consumer credit currently stands at $4.5 trillion, with $1.1 trillion in revolving debt and $3.4 trillion in non-revolving debt. From the previous quarter, total consumer credit increased by $107 billion, with revolving debt and non-revolving debt increasing by $56 billion and $51 billion, respectively. As the G.19 data are not inflation adjusted, it is reasonable to assume that part of the consumer credit growth, notably revolving debt, owes to recent price levels’ skyrocketing. However, even after adjusting for inflation, American households’ appetite for services increased (in part due to the lifting of COVID restrictions) and for goods was forcibly reduced. On the other hand, nonrevolving debt, which is closed-ended credit, grew moderately and was higher than pre-pandemic levels.With every quarterly G.19 report, the Federal Reserve releases a memo item covering student and motor vehicle loans’ outstanding levels on a non-seasonally adjusted basis. The most recent memo item indicates that, as of the first quarter of 2021, student loans stood at $1.8 trillion and motor vehicle loans stood at $1.3 trillion. Annualized, the changes in these two categories from the previous quarter are $58.4 billion and $83.6 billion, respectively. Together, these loans’ make up 90% of non-revolving debt (NSA), a share that has held approximately constant historically. Rising production costs resulting from ongoing supply chain issues and high interest rates have together kept car prices and, effectively, auto loan debt elevated. Related ‹ Solid Job Gains in AprilTags: auto loans, consumer credit, COVID-19, credit cards, federal reserve board, g.19, inflation, interest rates, non-revolving debt, student loan debt, supply chains

Consumer Credit Increases in First Quarter2022-05-09T13:21:39-05:00

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