Fed Rate Hike Possible Amid Inflation and Geopolitical Uncertainty
The following was written by NAHB Chief Economist Dr. Robert Dietz in the most recent issue of his bi-weekly newsletter, Eye on the Economy.
Despite the leadership change at the Federal Reserve, the bond market is now projecting that it is more likely than not that the next monetary policy move by the central bank is a federal funds rate increase rather than a cut.
The switch for market expectations from an easing cycle to tightening policy is due to macroeconomic conditions and risks, as well as fallout from current policy. Since March of this year, the two-year Treasury rate has increased by more than 70 basis points.
Erratic Economic Growth
First quarter GDP growth was revised lower to a 1.6% rate. Combined with Q4 2025 GDP data, economic growth has averaged only a 1% annual rate — near stall speed. Inflation-adjusted incomes declined 0.5% in April, with the personal saving rate falling to 2.6%, the lowest level since June 2022.
The labor market was stronger than expected in May, as the economy continues to expand despite significant macro headwinds. Job growth posted a 172,000 gain, with an additional 91,000 jobs reported in revisions for prior months. This was twice what was expected by economists. The unemployment rate came in at 4.3%. Residential construction had a small gain of 900 jobs in May, led by remodeling.
The near-term economic outlook is tied to whether energy prices and inflation fall with a resolution of the Iran war. Core inflation is at a 3.3% rate, well above the Fed’s 2% target and at a three-year high. Headline CPI increased to a 3.8% year-over-year rate, which was also a three-year high.
Key Factors Shaping the Housing Market
Higher interest rates have reduced housing activity. New single-family home sales declined 6.2% in April to a 622,000 annual rate and were down 11.3% from a year earlier, while inventory increased to 489,000 homes, equal to a 9.4 months’ supply. Despite national weakness, sales are up in the Midwest (7% thus far in 2026).
Custom home building is another bright spot for housing. Custom single-family starts totaled 36,000 in the first quarter of 2026, up 3% from a year earlier, while the one-year moving average custom market share stood at 20% of total single-family starts. Single-family built-for-rent starts totaled about 14,000 in the first quarter of 2026, down from 19,000 a year earlier, while the four-quarter total fell 26% to 62,000 homes. Construction has slowed due to concerns over the large investor proposal in Congress. The House legislation removes the problematic provision.
Looking forward, 2026 looks to be the second year in a row of cooling single-family construction. Mortgage interest rates are likely to remain above 6%, with inflation expectations elevated due to higher oil and commodity prices tied to the Iran war and the lingering impacts associated with tariffs.
A quick resolution for the Iran war will be a net positive for some of the inflation factors, however, the geopolitical situation is difficult to forecast. The other wild card for the economy is productivity growth, which will raise incomes and produce deflationary forces. However, such gains are not likely to materialize in the near-term.