On September 18, 2024, the Federal Reserve cut interest rates by 50 basis points. Many are celebrating this as a sign that our massive inflation is under control, and we are seeing a strengthening in our economy. The fact is that inflation is still not under control. At best inflation has softened. Many opportunists want to capitalize on this to take a victory lap to benefit their cause, but inflation is still alive and well. With respect to housing, this rate cut does nothing to stabilize home prices and rents. An argument can be made that due to this large cut, it will do little to increase inventory supply and only cause homebuyer demand to shoot up making competition among homes much more prevalent. An already stressed housing market will in turn see less affordability for homebuyers, further adding to the housing market affordability crisis.
The Consumer Price Index (CPI) released on September 11 eased slightly, increasing 2.5% over the past year in August compared to 2.9% over the past year in July. Although inflation is much lower than it’s high at 9.1% and at the lowest since 2021, it is still higher than the Fed’s goal of 2%. The CPI is not favoring a rate cut at all because the inflation rate is still above the goal. At most, a cut of 25 basis point was expected as a cautionary step, but the Fed took a bolder move to reduce the rate by 50 basis point. The 50 basis point reduction is a threat to the housing sector which makes up a huge portion of the CPI.
Housing costs are a majority influencer in the shelter category of CPI. Despite the softening of the overall CPI, the inflation that continues to exist is widely attributed to the continued increase in housing costs. In the month of August, the housing costs for home prices and rent each increased by the largest month-to-month this year of 0.5% and 5.2% year-to-year. Housing costs continue to rise, and affordability continues to decline confirming that inflation is alive and well.
In anticipation of a Fed rate cut, the mortgage rate reduction has already been baked in since July 2024. Mortgage rates had already come down ahead of this Fed Rate cut. The current mortgage rate hovers around 6.2% and is expected to stay at this level for the interim. This Fed rate cut is convenient before a presidential election, but the reality is that the mortgage rates are still higher than most fixed mortgage rates held by existing homeowners.
The main source of soaring housing costs is due to the lack of inventory supply. The inventory supply has been depleted because of the “lock-in effect” of homeowners. An estimated 62% of homeowners have mortgage rates of less than 4% and 86% of homeowners have mortgage rates of less than 6%. The 50 basis point cut in the interest rate will have little impact on reducing the “lock-in effect”. It is not enough to get the homeowners to sell. Home sellers have to go somewhere, also making them future homebuyers or renters. They do not want to give up their low fixed mortgage rates so they are staying put. The 50 basis point cut will actually cause those homebuyers who were waiting on the sideline to anxiously emerge to purchase a home again causing a bidding war to drive up the housing prices.
The true indicator if housing affordability is moving in the right direction is to study how the inventory supply reacts to the mortgage rate changes. If the demand increases and outweighs any increase in inventory, then prices will continue to surge. If we see more substantial drops in mortgage rates, it may be enough to encourage homeowners to sell improving the inventory shortage. More homes on the market would help ease housing prices and improve housing affordability. However, the “lock-in effect” is so embedded that the demand will continue to outweigh the supply and housing costs will rise.
Poor consumer sentiment in the housing market has caused many homebuyers to take a cautionary pause because affordability decline has put a strain on many households. We have seen that the homes sales are at record low levels, despite the still surging home prices. Doug Duncan, Fannie Mae’s chief economist, has supported this theory that the mortgage rates were already baked in since July and consumer sentiment has not improved. Following the rate cut, Duncan stated that “we’ve not seen evidence of a corresponding increase in loan application activity, nor has there been an improvement in consumer homebuying sentiment”1 Inventory remains the single most important factor rising housing costs and loss of affordability. Duncan describes that “we expect affordability to remain the primary constraint on housing activity for the foreseeable future, and we now think full-year 2024 will produce the fewest existing home sales since 1995”1 The Fed interest rate cut does nothing to solve the inventory problem and will actually widen the disparity between inventory and homebuyer demand causing housing costs to rise even further and add to the existing inflation.
Based on the data that does not support a Fed interest rate cut, it is hard to disassociate it from being politically motivated before an election. If the Fed was genuine in its adjustment, they would have taken the housing market costs into consideration as a majority influencer to CPI and a huge driver of the existing inflation. Chairmen Powell was specifically asked by a reporter “Some of your colleagues have expressed concerns that with starting to cut rates you could reignite demand in housing and see [U.S. home] prices go up even more. What’s the likelihood of that and how would you react to that?” In response Chairman Powell gave a very elusive answer saying “The housing market, it’s hard to game that out. The housing market is, in part, frozen because of lock-in, lower rates, people don’t want to sell their home because they have a very low mortgage and it would be quite expensive to refinance.”1 It is shocking that the Fed did not take housing costs into consideration in their unprecedented 50 basis point drop. Powell futher went on to say “The real issue with housing is that we have had, and are on track to continue to have, not enough housing. And so it’s going to be challenging, it’s hard to zone lots in places people want to live. All of the aspects of housing are far more difficult, and where are we going to get the supply? And this is not something the Fed can really fix.”
The Fed is uncommitted to finding solutions to the housing market affordability crisis. If housing affordability is not under control, nor will inflation be tamed. It is too big of a factor to ignore. It is apparent that the Fed is politically motivated by these cuts to try to influence consumer sentiment that all is good in the inflation world and mortgages rates are going down. This 50 basis point is a hit and run on the housing market which as the Fed states “…the supply question will have to be dealt with by the market, and also by the government.”
In summary, the Fed rate cut will not have an influence on current mortgage rates that have already had reductions accounted for in July in anticipation of this Fed rate cut. The aggressive 50 basis point cut instead of the preferred softer 25 basis point rate cut increases the likelihood of causing homebuyer demand to further outweigh the supply of homes for sale. Bidding wars due to increased homebuyer demand will raise home prices. It is important to note that many will attribute the Fed rate cut as a victory for inflation conveniently before a Presidential election, but there is nothing to rave home about. The continuing surge of housing prices making up the majority of CPI will only keep inflation elevated and housing affordability at a low. This will take bold policy changes to massive government spending, increased revenue, and wage growth.
September 19, 2024
By Sophia Georges
Copyright 2024 - Realsophy Real Estate, Sophia Georges
