Fed Rate Cut Good for Housing

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In a policy change widely expected and good for housing and home building, the Federal Reserve today reduced its key, short-term federal funds rate by 25 basis points to a top rate of 2.25%. The housing sector continues to face affordability headwinds, and today’s action by the Fed will help by reducing borrowing costs. The evolution of the central bank’s policy over the last three quarters is an important reason why mortgage interest rates have declined from late-2018 cycle highs. Given that the housing market faced a 10-year low for housing affordability last fall, the Fed’s approach is a net positive for future housing demand and home construction, while offering an offset (but only a partial one) for rising construction costs. These costs are limiting housing inventory, particularly at the entry-level market. Moreover, higher production costs have caused housing affordability to decline in recent years and are the primary driver for NAHB’s estimate for generally flat conditions for new home sales and starts in 2019. With respect to the overall economy, the Fed characterized the labor market as "strong," with economic activity rising at a "moderate" rate. This mirrors the home building economic perspective of a slowing overall economy, ongoing labor shortages, and late cycle concerns over housing affordability. The Fed noted that "business fixed investment has been soft," and the housing market has mirrored that trend in recent quarters. Inflation was described by the Fed as running below its target rate of 2%, suggesting the central bank has policy room to maneuver to reduce rates if the economy continues to slow. That said, additional rate cuts in the near-term are not guaranteed. Indeed, NAHB believes some investors are being too aggressive with an expectation of 75 basis points of rate reduction over the next few quarters. The NAHB forecast includes an additional 25 basis point cut in the Fed funds rate late in 2019 given muted inflation and slowing growth. The late cycle housing market soft patch that began during the second half of 2018 provides clear evidence of ongoing macro risks, with residential fixed investment down for the last six quarters. NAHB Chief Economist Robert Dietz provides more details in this Eye on Housing blog post.

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