Fed raises rates .75% again but can it ‘correct’ housing?

Federal Reserve Board Chair Jerome Powell answers reporters’ questions at the FOMC press conference on September 21, 2022. Photo: Federal Reserve Board

The Federal Reserve’s Federal Open Market Committee landed another 75-basis-point blow in its fight against inflation today and anticipates this aggressive stance is likely to last beyond 2023. The third consecutive 0.75% increase in the federal funds rate (interest banks charge each other for overnight loans) target range was widely expected. The median of FOMC participants’ forecasts suggest they might raise the rate an additional 125 basis points this year and expect additional increases through 2023.

Housing due for a ‘correction’

Housing has become a thorny economic peculiarity. The significance of exorbitant rents and home prices underpinning inflation has intensified since fuel prices began to taper. Existing home sales have fallen for seventh months straight and mortgages are at their highest rates since 2008. New housing starts rose 12.2% in August and have increased in three of the five months on record since the Fed started raising interest rates in March. Yet housing prices in the current low-inventory atmosphere remain high, with the median U.S. sale in the second quarter above $440,000.

In today’s press conference, Fed Chairman Jerome Powell spoke of the three-percentage-point increase in the federal funds rate so far this year as “applying pressure” or “restricting” various segments of the economy. The only topic to which he applied the word “correction” was housing.

The median FOMC forecast of 2023 unemployment rose to 4.4%. Graphic: Wells Fargo Economics

“The deceleration in housing prices we’re seeing should bring prices more closely in line with rents and other housing market fundamentals, and that’s a good thing,” Powell said. But it didn’t sound like a path to resolution was in clear view when he added, “For the longer term, what we need is for supply and demand to get better aligned so that housing prices go up at a reasonable pace and that people can afford houses again. We probably need the housing market to go through a correction to get back to that place.”

He mentioned longer-term housing-market issues including the lack of available lots close to employment centers, restrictive zoning and builders’ difficulties getting workers and materials. Without mentioning what might bring about a correction, Powell said, “From a business-cycle standpoint, this difficult correction should put the housing market into better balance.

“I think shelter inflation’s going to stay high for some time. We’re looking for it to come down, but it’s not exactly clear when that will happen. Hope for the best, plan for the worst.”

Chance of recession

The median participant’s expectation of where the federal funds rate would be at the end of 2022 rose to 4.4%. The target range is currently 3.0% to 3.25%. The median year-end estimates for the federal funds rate in 2023 and 2024 were 4.6% and 3.9%, respectively.

The FOMC is concerned that higher-than-2% inflation is becoming increasingly entrenched in business and consumer expectations, a condition that Powell says makes fighting inflation much harder. FOMC members now expect Personal Consumption Expenditures Price Index (core PCE) to remain above 3% through next year and above 2% through 2025.

The median of FOMC member forecasts for GDP anticipates growth of just 0.2% this year and 1.2% next year. Graphic: Wells Fargo Economics

The protracted fight against lingering inflation drew down estimates for real GDP growth, to just 0.2% this year and 1.2% next year. Perhaps more sobering was the upward adjustment to unemployment rate projections in 2023. The median FOMC forecast rose to 4.4%, from 3.9% in the June.

“Such an outcome could still be construed as a ‘soft-ish’ landing for the economy,” said Jay Bryson, Ph.D., chief economist at Wells Fargo Securities, “But the committee appears to be inching toward our own view that it will take a mild recession to get inflation firmly back to the 2% target.”

Why so aggressive?

The labor market is only beginning to show some signs of slowing down.

Powell said in order to bring the supply of labor more in line with demand, they will have to raise interest rates to “a restrictive level and keep it there for some time.” He defined “restrictive” as “putting meaningful downward pressure on inflation.” He added that he feels the 175 basis points added today moved rates into the lowest levels of what might be considered “restrictive,” and “we’ve still got a ways to go.”

The FOMC will adjust its policies in an effort to keep growth running below trend, to better balance labor supply with demand and ultimately to produce clear evidence of inflation moving down to the 2% target.

If today’s 4.6% forecast of the funds rate at 2023’s end of holds true, that gives you an idea of how far the FOMC expects they’ll have to go in the short term. Their forecast of 2023 unemployment increasing to 4.4% as a result is another measure of their commitment to controlling inflation. Historically, that’s enough unemployment growth to bring on a recession, but Powell pointed out some reasons to believe the current economy might be strong enough to weather the storm.

There are nearly twice as many vacant jobs in this economy as there are unemployed people.

“It’s plausible that job openings could come down significantly – and they need to – without as much of an increase in unemployment as has happened in other historical episodes,” Powell said.

Another unique element of today’s inflation is the contribution of the obvious series of supply shocks – the pandemic, the reopening of the economy and the additional strain of Russia’s invasion of Ukraine.

“They’ve all contributed to inflation – the kind of events not seen in prior business cycles,” Powell said. “How much these factors matter in this sequence of events remains to be seen.”