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The good news? The Fed doesn’t expect a recession. The bad news? Housing.

Economists project limited housing activity as the impact of tight monetary policy continues to reverberate through the economy

After a year’s worth of warnings about a recession, Federal Reserve Chair Jerome Powell said Wednesday that the central bank’s staff no longer forecasts a nationwide economic downturn. It’s welcome news for the economy to achieve a soft landing, a scenario in which inflation falls, unemployment remains relatively low and a recession is avoided.

Housing activity, however, will be limited as the impact of tighter policy continues to reverberate through the economy, housing experts and economists projected following the Fed’s decision to raise interest rates by 25 basis points on Wednesday. 

Mortgage rates are expected to remain elevated until inflation moves to a level more consistent with the Fed’s mandate. High mortgage rates have triggered a rate lock-in effect across the country – disincentivizing homeowners to move and finance their new home with higher rates. 

“High mortgage rates triggered by the Fed’s policy have caused more sellers to sit on the sidelines given the large differential between the rate they enjoy on their current home compared to the possible interest rate on any home they may purchase today,” said Marty Green, principal at Polunsky Beitel Green, a law firm for residential mortgage lenders.

Data from Redfin showed that about 92% of homeowners have a rate below 6% and a record 60% of mortgage holders have lived in their home for four years or less – further contributing to the supply shortage.

“Higher mortgage rates change the trade-up calculation for existing homeowners and are keeping as many as 1 in 7 out of the market because they don’t want to give up their existing low rate,” Danielle Hale, chief economist at noted. 

Existing home sales dropped to a seasonally adjusted annual rate of 4.16 million in June from the previous month. Year-over-year, sales dipped 18.90% from 5.13 million in June 2022.

Hale expects the number of home homes for sale to decline this year, and continue to be a damper on home sales. 

“A large swath of outstanding mortgages has below-market rates, and this has led to a restriction in the supply of existing homes for sale,” Ruben Gonzalez, chief economist at Keller Williams, said.

During his press conference with reporters, Powell acknowledged that the housing market has cooled due to high rates, but also said it “has a ways to go” before home prices fall.

Powell also said more supply was coming. Though housing starts boomed in May and fell slightly to a seasonally adjusted 1.43 million units last month, supply is mostly coming from multifamily rental construction. Permitting data suggests future multifamily supply is slowing and developers of such projects are highly sensitive to high interest rates.

For now, first-time homebuyers are the most impacted group as higher mortgage rates cut into their purchasing power. 

High rates have made affordability exceedingly challenging, and low inventory in return increased competition, especially at lower price points.

The combined impact of higher rates and higher home prices has driven the cost of financing the typical listed home up more than $250 or 12.4% from a year ago; and up more than $1,100 or 96.5% from June 2020, nearly doubling the cost in three years, Hale noted. 

It’s not just the buyers that are getting sidelined. 

Renters are expected to get hit with higher rental rates, according to Justin Barry, partner at Morris, Manning & Martin.

While the Fed is attempting to stave off inflation by raising interest rates, it could actually have the opposite effect on rents, according to Barry.

“With each round of rate hikes, the Fed puts increasing pressure on multifamily properties with floating-rate loans or maturing fixed-rate loans. Many owners are attempting to pass along the increased financial burdens to tenants by increasing rental rates, provided that demand in a particular submarket supports higher rental rates,” Barry said.

With affordability challenges to persist, demand for new housing construction will follow.

“The onus is on homebuilders, as well as municipal, state and federal authorities, to take steps that will increase construction activity of owner-occupied single-family and multifamily housing to ease the affordability burden on would-be homeowners,” Kyle Enright, president of lending at Achieve, said.

Last hike of the year? The housing industry hopes so

While Powell emphasized any future policy decisions would be made on a meeting-by-meeting basis and that in the current environment, there is expectation that the central bank will pause its rate hike for this year.

“The Fed sounded surprised that we have disinflation factors without a hit to the labor market, which is positive because they might believe now they don’t need a job loss recession to help inflation data improve,” Logan Mohtashami, lead analyst at HousingWire said.

During a press conference with reporters on Wednesday, Powell said the Fed has “seen the beginnings of disinflation without any real costs in the labor market.”

​​Although inflation dropped to 3% in June, it is still above the Fed’s goal of 2%. Hiring still remains strong and the unemployment rate is hovering at very low levels. 

If jobless claims get better, they might hike one more time, but they’re sounding more confident than they’re restrictive now, Mohtashami said.

Although the Fed previously signaled it was looking at one or two more increases this year, “we’re starting to see other weaknesses in the economy” and that may put the Fed on a pause after this month’s rate hike, Melissa Cohn, regional vice president of William Raveis Mortgage, said.

Goldman Sachs projected that the FOMC will ultimately remain on hold at the September meeting as the committee leadership has advocated for a “careful pace” of tightening.

“If the Fed isn’t careful, this critical industry may once again slow to crawl in the fall and winter,” Green said. 

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