The Fed’s chairman, Jerome Powell, has repeatedly said that the central bank’s “overarching focus” right now is to slow inflation. The Fed applies the brakes on inflation by raising short-term interest rates. When the central bank tugs short-term rates higher, mortgage rates usually rise, too.
In fact, the Fed has targeted mortgage rates specifically. During the depths of the pandemic, the central bank bought government and mortgage debt, pushing mortgage rates to record lows. Now, the Fed is gradually reducing those debt holdings, which is expected to force rates upward.
This so-called reduction of the Fed’s balance sheet is just beginning. As Powell pointed out in a news conference on July 27 after the Fed’s latest rate increase, the shedding of these assets is still ramping up and will “go to full strength” in September. As that date approaches, mortgage rates will bear additional upward pressure.
Affordability in the balance
Home prices have been rising swiftly along with mortgage rates, a combination that demoralizes buyers because homes become less affordable. Look at what happened to affordability from January to June. When you take the median home resale price and average mortgage rate in both months, the monthly payment on a typical home bought in June was $774 higher than its counterpart in January (after a 5% down payment).
If there’s any good news for home buyers, it’s that prices aren’t rising as fast as they once were. In June, the median resale price of an existing home was 13.4% higher than a year before, whereas, in February, the year-over-year price increase was 17.1%. Higher mortgage rates helped drive the price slowdown.
Rising mortgage rates have had an even deeper impact on the median price of new homes, which went up 7.4% in the 12 months ending in June, according to the U.S. Census Bureau. As recently as April and May, the year-over-year price increases had exceeded 20%. Again, the Fed’s campaign of rate increases has changed the pace of home prices increases.
The Fed is determined
The bottom line is that house prices continue to rise, making it difficult for would-be buyers to find homes they can afford. But it’s hard to dispute that the Federal Reserve is succeeding in slowing down runaway house prices. Eventually, in a roundabout way, the slowdown in home prices will be reflected in the overall inflation rate.
Is it necessary for the Fed to cause a recession to chop the inflation rate to its 2% goal? Powell danced around that question in his July 27 news conference. He said he’s not the person who defines when a recession begins and ends, and he added, “our goal is to bring inflation down and have a so-called soft landing, by which I mean a landing that doesn’t require … a really significant increase in unemployment.”
But he also implied that he’s willing to restrict the U.S. economy, including the strong job market, if that’s what’s necessary to bring inflation under control. If and when the Fed succeeds in cutting the inflation rate to 2%, mortgage rates could decline because mortgage rates respond to inflation expectations.
What happened in July
The average 30-year fixed mortgage rate fell slightly in July after having risen seven months in a row. It averaged 5.66% in June and 5.55% in July.
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In my July forecast, I predicted that mortgage rates would go up, driven by high inflation and the Fed’s efforts to control it. (This is the same reasoning behind the August forecast of higher mortgage rates.) But investors positioned themselves for a recession by buying bonds, which had the indirect effect of pushing down on mortgage rates. I’ve guessed correctly in eight of the past 12 months.