A Rate Cut from the Fed: What Will the Terminal Rate Be?

2024-11-07T15:16:18-06:00

The Fed cut the short-term federal funds rate by an additional 25 basis points at the conclusion of its November meeting, reducing the top target rate to 4.75%. However, while the Fed noted it is making progress to its 2% inflation target, it did not provide post-election guidance on the pace and ultimate path for future interest rate cuts. The bond market is not waiting, with the 10-year Treasury rate rising from 3.6% in mid-September to close to 4.3% due to changing growth and government deficit expectations. Today’s statement from the Fed noted: “Recent indicators suggest that economic activity has continued to expand at a solid pace. Since earlier in the year, labor market conditions have generally eased, and the unemployment rate has moved up but remains low. Inflation has made progress toward the Committee’s 2 percent objective but remains somewhat elevated. The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. The Committee judges that the risks to achieving its employment and inflation goals are roughly in balance. The economic outlook is uncertain, and the Committee is attentive to the risks to both sides of its dual mandate.” Inflation risks for 2025 are evolving. The policy risks for the central bank had recently been between inflation (decreasing risks) and concerns regarding the health of the labor market (risks rising). However, the 2024 election result changes this outlook somewhat. In particular, the election increases the probability of additional economic growth, a tighter labor market, larger government deficits, and higher tariffs. All of these factors can be inflationary, even if they yield other macroeconomic benefits. Consequently, the Fed will need to recalibrate its economic and policy outlook given the large number of changes that markets have digested in just the past week alone. In particular, how far will the Fed ultimately cut into 2025 and perhaps 2026? A 3% terminal federal funds rate is unlikely. Some commentators have suggested a 4% rate would at least be a threshold of reevaluation. NAHB’s outlook is for a terminal rate of 3.25%, perhaps 3.5%. However, that decision, or destination, will be dependent on factors like tariff adoption. Markets and analysts will receive additional information at the conclusion of the December Fed meeting, which will include an update of the central bank’s Summary of Economic Projections. Given the election discussion, is worth noting that the Fed does not try to anticipate changes to future fiscal policy. The Fed will study and model anticipated changes, but such impacts would not be formally incorporated into the Fed’s outlook until such proposals are, at the very least, fully detailed and analyzed. All market participants should be aware that rising government debt levels will push nominal long-term interest rates higher. While the question of the future policy path matters for long-term interest rates, there is a direct benefit to current easing like today’s rate cut. For example, the November rate reduction will be felt for builder and land developer loan conditions. Interest rates for such loans should move lower by approximately 25 in the coming weeks. A reduction for the cost of builder and developer loans is a bullish sign for housing affordability. The pace of overall inflation has remained elevated due to the growth of housing/construction costs and elevated measures of shelter inflation, which can only be tamed in the long-run by increases in housing supply. Fed Chair Powell has previously noted it will take some time for rent cost growth to slow. Given recent tight financing conditions, however, the Fed noted that while consumer spending is resilient, “…activity in the housing sector has been weak.” All things considered, with inflation having moved lower (the September core PCE measure of inflation is at 2.7%, down from 3.7% a year ago), there is clearly policy room for future rate reductions as the Fed normalizes monetary policy. A further cut to the federal funds rate in December, to a 4.5% top rate, seems likely. After that, given expected changes for fiscal policy and fiscal policy impacts, the Fed is likely to slow its pace of rate cuts, perhaps moving to one 25 basis point cut per quarter in 2025 to the ultimate terminal rate. As noted earlier, the level of this terminal rate is likely to be reevaluated in the coming months. Discover more from Eye On Housing Subscribe to get the latest posts sent to your email.

A Rate Cut from the Fed: What Will the Terminal Rate Be?2024-11-07T15:16:18-06:00

Existing Home Sales Slide Despite Lower Mortgage Rates

2024-09-19T13:15:15-05:00

Existing home sales fell to a 10-month low in August despite easing mortgage rates and improved inventory, according to the National Association of Realtors (NAR). Home sales remained sluggish as the lock-in effect kept home prices elevated. Meanwhile, the share of first-time buyer in August dropped to a record low. However, we expect increased activity in the coming months as mortgage rates continue to moderate. Improving inventory is likely to ease home price growth and enhance affordability. Homeowners with lower mortgage rates have opted to stay put, avoiding trading existing mortgages for new ones with higher rates. This trend is driving home prices higher and holding back inventory. With the Federal Reserve beginning its easing cycle at the September meeting, mortgage rates are expected to gradually decrease, leading to increased demand and unlocking lock-in inventory in the coming quarters. Total existing home sales, including single-family homes, townhomes, condominiums, and co-ops, fell 2.5% to a seasonally adjusted annual rate of 3.86 million in August, the lowest level since October 2023. On a year-over-year basis, sales were 4.2% lower than a year ago. The first-time buyer share dropped to 26% in August, the lowest level since November 2021, down from 29% in both July and August 2023. The existing home inventory level rose from 1.34 million in July to 1.35 million units in August and is up 22.7% from a year ago. At the current sales rate, August unsold inventory sits at a 4.2-months supply, up from 4.1-months last month and 3.3-months a year ago. This inventory level remains low compared to balanced market conditions (4.5 to 6 months’ supply) and illustrates the long-run need for more home construction. However, the count of single-family resale homes available for sale is up almost 21.4% on a year-over-year basis. Homes stayed on the market for an average of 26 days in August, up from 24 days in July and 20 days in August 2023. The August all-cash sales share was 26% of transactions, down from 27% in both July and a year ago. All-cash buyers are less affected by changes in interest rates. The August median sales price of all existing homes was $416,700, up 3.1% from last year. This marked the 14th consecutive month of year-over-year increases. The median condominium/co-op price in August was up 3.5% from a year ago at $366,500. This rate of price growth will slow as inventory increases. Existing home sales in August were mixed across the four major regions. In the Northeast, South, and West, sales fell by 2.0%, 3.9%, and 2.7%, respectively, while sales in the Midwest remained unchanged. On a year-over-year basis, sales decreased in the Midwest (-5.2%), South (-6.0%) and West (-1.4%). Sales in the Northeast were unchanged from a year ago. The Pending Home Sales Index (PHSI) is a forward-looking indicator based on signed contracts. The PHSI fell from 74.3 to 70.2 in July due to persistent affordability challenges. On a year-over-year basis, pending sales were 8.5% lower than a year ago per National Association of Realtors data. Discover more from Eye On Housing Subscribe to get the latest posts sent to your email.

Existing Home Sales Slide Despite Lower Mortgage Rates2024-09-19T13:15:15-05:00

Inflation Continued to Slow, Setting Stage for Rate Cuts

2024-09-11T10:16:13-05:00

Inflation eased further in August, reaching a new 3-year low despite persistent elevated housing costs. This inflation report is seen as the final key piece of data before the Fed’s meeting next week. The headline reading provides another dovish signal for future monetary policy, after recent signs of weakness in job reports. Although shelter costs have been trending downward since peaking in early 2023, they continue to exert significant upward pressure on inflation, contributing over 70% of the total 12-month increase in core inflation. As consistent disinflation and a cooling labor market bring the economy into better balance, the Fed is likely to further solidify behind the case for rate cuts, which could help ease some pressure on the housing market. Though shelter remains the primary driver of inflation, the Fed has limited ability to address rising housing costs, as these increases are driven by a lack of affordable supply and increasing development costs. Additional housing supply is the primary solution to tame housing inflation. However, the Fed’s tools for promoting housing supply are constrained. In fact, further tightening of monetary policy would hurt housing supply because it would increase the cost of AD&C financing. This can be seen on the graph below, as shelter costs continue to rise at an elevated pace despite Fed policy tightening. Nonetheless, the NAHB forecast expects to see shelter costs decline further in the coming months, as an additional apartment supply reaches the market.  This is supported by real-time data from private data providers that indicate a cooling in rent growth. The Bureau of Labor Statistics reported that the Consumer Price Index (CPI) rose by 0.2% in August on a seasonally adjusted basis, the same increase as in July. Excluding the volatile food and energy components, the “core” CPI increased by 0.3% in August, after a 0.2% increase in July. The price index for a broad set of energy sources fell by 0.8% in August, with declines in electricity (-0.7%), gasoline (-0.6%) and natural gas (-1.9%). Meanwhile, the food index rose 0.1%, after a 0.2% increase in July. The index for food away from home increased by 0.3% while the index for food at home remained unchanged. The index for shelter (+0.5%) continued to be the largest contributor to the monthly increase in all items index. Other top contributors that rose in August include indexes for airline fares (+3.9%) and motor vehicle insurance (+0.6%). Meanwhile, the top contributors that experienced a decline include indexes for used cars and trucks (-1.0%), household furnishings and operations (-0.3%), medical care (-0.1%) and communication (-0.1%). The index for shelter makes up more than 40% of the “core” CPI. The index saw a 0.5% rise in August, following an increase of 0.4% in July. The indexes for owners’ equivalent rent (OER) increased by 0.5% and rent of primary residence (RPR) rose by 0.4% over the month. These gains have been the largest contributors to headline inflation in recent months. During the past twelve months, on a non-seasonally adjusted basis, the CPI rose by 2.5% in August, following a 2.9% increase in July. This was the slowest annual gain since February 2021. The “core” CPI increased by 3.2% over the past twelve months, the same increase as in July. The food index rose by 2.1%, while the energy index fell by 4.0%, ending five consecutive months of year-over-year increases for the energy index since February 2024. 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 than overall inflation, the real rent index rises and vice versa. 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). In August, the Real Rent Index rose by 0.1%, after a 0.3% increase in July. Over the first eight months of 2024, the monthly growth rate of the Real Rent Index averaged 0.1%, slower than the average of 0.2% in 2023. Discover more from Eye On Housing Subscribe to get the latest posts sent to your email.

Inflation Continued to Slow, Setting Stage for Rate Cuts2024-09-11T10:16:13-05:00

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