Fed Chairman: Higher Rates Will Linger Longer

NAHB Chief Economist Robert Dietz recently provided this housing industry overview in the biweekly newsletter Eye on the Economy.

Because of strong data at the start of 2023, particularly for job creation and persistent inflation pressure, Federal Reserve Chairman Jerome Powell informed Congress this week that the terminal rate (long-term target) for the Fed’s federal funds rate is likely to be higher than the Fed itself anticipated just a few months ago. Moreover, Powell also indicated the pace of tightening could accelerate again, after a recent downshift for Fed hikes that led to just a 25 basis-point increase at the start of February.

Taken together, Powell’s congressional remarks have convinced the bond market that the top federal funds rate could exceed 5.5% (it is currently 4.75%), and 50 basis-point increases could be in the cards for the March and May meetings. And rates are expected to remain at this level through the end of 2023, per the Fed's commentary. This anticipation is the reason long-term interest rates have moved higher in recent weeks, increasing from about 3.7% in early February to almost 4% this week. Mortgage rates, per Freddie Mac, were averaging 6.65% last week on the 30-year fixed-rate mortgage, and that rate will move up in the next publication of data. However, it should remain lower than the approximate 7.1% rate experienced last October.

The Fed is seeking to return inflation to a 2% level without producing a recession. The NAHB forecast projects the slowing economy will ultimately be judged as a mild recession for a portion of 2022 and 2023, as exemplified by the slowing of the housing market since the first quarter of 2022. Powell’s remarks are consistent with this outlook; however, his comments represent a moderately higher terminal rate than NAHB forecasted at the International Builders’ Show in February. Nonetheless, the Fed has moved to a data dependent mode in 2023, after the rapid tightening of rates (using 75 basis-point hikes) in 2022.

Higher interest rates will further slow new and existing home sales, despite promising data in January. New single-family home sales increased 7% in January to a 670,000 seasonally adjusted annual pace. Although this pace was more than 19% lower than the January 2022 rate, it was above forecast and an indicator that even slightly lower interest rates could spark demand for new construction. Given the reduced level of housing demand, new home inventory remains elevated at a 7.9-month supply. Median new home pricing has declined for three straight months, but at $427,500, it still stands significantly higher than pre-Covid norms.

In addition to weak conditions in the for-sale market, multifamily sentiment continues to remain low. The NAHB Multifamily Production Index increased two points from the previous quarter to 34 but remains well below the breakeven level of 50, pointing to future declines for multifamily construction starts. Even though many multifamily developers continue to see strong demand, the supply in some markets is beginning to catch up, as evidenced by multifamily starts greatly outpacing completions.

Subscribe for free to Eye on the Economy.