Fed Lifts Rates by 0.75% Again to Fight Inflation but Housing Already in a Recession

Continuing its fight to rein in stubbornly high inflation, the Federal Reserve yesterday hiked the federal funds rate by 75 basis points to an upper bound target of 2.5% following a similarly aggressive move in June. The Fed rate hikes slow the economy by making business and consumer borrowing costs more expensive. This has already had an impact on the interest rate sensitive housing sector, which is now in the midst of a housing industry recession.

In fact, just about every housing indicator is showing signs of weakness, including seven straight months of declines for home builder sentiment. Single-family starts and permits both fell below a 1 million annual pace and to a two-year low in June, and new home sales also plunged in June, marking the second time that sales fell below a 600,000 annual pace since Oct. 2018. Adding in declines for pending home sales and rising sales cancellation rates clearly paints a picture of a weakening housing sector.

Indeed, there is also an open question whether the entire economy experienced a recession during the first half of 2022. Government data released this morning shows that preliminary gross domestic product fell 0.9% in the second quarter, marking the second consecutive quarter of negative growth. Some analysts define two consecutive quarters of negative economic growth as a recession but the National Bureau of Economic Research is usually the final arbiter.

At a news conference yesterday, Fed Chairman Jerome Powell said he did not think the economy was in a recession and that preliminary GDP numbers should be “taken with a grain of salt” because they are often revised significantly. Powell also cited other areas of the economy that are performing well, including the low unemployment rate. However, he did acknowledge that the path to avoiding a recession has grown narrower than just a few months ago and that “it may narrow further” as the Fed continues to stand behind tough choices to curb inflation that climbed to 9.1% in June, a 40-year high.

“Restoring price stability is something we have to do,” Powell said. “There isn’t an option to fail to do that, because that is the thing that enables you to have a strong labor market over time.”

Following the largest two back-to-back rate hikes since 1994, market participants have reduced their expectations for future aggressive Fed rate hikes, which is perhaps a sign of renewed confidence in the ability of the central bank to bring inflation down (even if it means a recession in the so-called hard landing scenario). Higher interest rates and lower economic growth will eventually bring inflation rates down.

The path of required additional tightening will depend on economic growth and inflation data, moving the Fed to a more data dependent stance. This is a signal that the Fed could slow the pace of its rate hikes in the coming months.

NAHB Chief Economist Robert Dietz provides more analysis in this Eye on Housing blog post.