Following the U.S. Labor Department’s report last week showing that the U.S. economy added 235,000 jobs in February and that unemployment had fallen to 4.7%, the Federal Open Market Committee (FOMC) on Wednesday voted to increase the Fed Funds Rate to 0.75%-1.0% from the current range of 0.50%-0.75%, the second of three expected rate hikes this year.
“Information received since the [FOMC] met in February indicates that the labor market has continued to strengthen and that economic activity has continued to expand at a moderate pace,” the committee said in its usual statement. “Job gains remained solid and the unemployment rate was little changed in recent months. Household spending has continued to rise moderately while business fixed investment appears to have firmed somewhat. Inflation has increased in recent quarters, moving close to the Committee’s two percent longer-run objective.”
In reaction to the rate hike, Lindsey Piegza, chief economist at Stifel Fixed Income, said the 25-basis-point rate increase “was widely anticipated and arguably already priced into the market.”
She added, however, that it was “somewhat disappointing” that the FOMC offered “few hints as to the number or timing of future rate hikes.”
“Acknowledging the improvement in the underlying economy, the Fed remained cautious in overemphasizing such improvement, particularly on the inflation side,” she said. “After all, committee members are all too aware that the recent increase in prices stems in good part from a reversal in energy costs temporarily buoying the year-over-year calculation.
“However, as energy prices stabilize in the spring or summer, the upward momentum is expected to wane, eventually putting downward pressure on topline inflation measures,” she added.
In a separate statement, Steve Hovland, director of research for HomeUnion, noted that, “Uncertainty surrounding the direction of economic policy from the new Trump administration wasn’t enough to provide the FOMC ample reasons to delay normalizing interest rates.”
“That mentality marks a stark contrast in the FOMC’s stance from just one year ago, when seemingly any hiccup provided room for pause,” Hovland said. “In fact, low energy prices and a 12 percent drop in the S&P 500 in the early months of 2016 derailed the committee’s plan for three rate hikes last year. Brexit and the presidential election proved to be too much for the FOMC to lift the federal funds rate more than one time in 2016, mirroring progress made in 2015 to normalize interest rate policy.
“The dovish Fed is being pressured to lift interest rates in the current environment,” Hovland adds. “In August 2015, the markets collapsed at the prospect of higher rates, forcing the Fed to clearly broadcast the December rate hike. Following that increase, the markets reacted poorly and effectively erased two potential hikes in 2016. However, the equity markets are near all-time highs, payrolls have expanded for a record 77 consecutive months, and the unemployment rate has been at or below the ‘full employment’ threshold of 5 percent for 17 months. There is very little evidence to suggest the economy is sufficiently weak to keep interest rates at crisis levels.”
Hovland said he thinks the Fed “will hit its target of three rate hikes this year.”
“Beyond the March increase, the Fed is also expected to lift rates in June and December,” he said. “A new Scottish referendum for independence after the United Kingdom leaves the EU could push the Fed back into a dovish stance. Additionally, the response by the European Union to Brexit could produce headwinds in the U.S. If Germany and France decide to punish the U.K. to prevent other defections from the EU, a more lenient interest rate policy in the U.S. could persist longer. Nonetheless, the economy is strong and current administrative policies should create more jobs and lead to higher inflation, justifying the Fed’s more aggressive stance.”
Hovland added that – following the hike – real estate investors would need to act quickly to secure financing at lower rates.
“In the rising interest rate environment, a significant amount of portfolio shuffling is anticipated to occur,” he said. “Elevated rates could cool the robust equity markets and capital in low-yield bonds will need to shift to higher yielding properties. A housing shortage, elevated rent growth and homeownership near all-time lows will push some capital into rental real estate in the coming months.”
The big question for those in the mortgage and housing industries is whether the rate increase will put a damper on spring home sales.
“If you are buying a house with a $300,000 mortgage, a one percent difference from 4% to 5% means your monthly mortgage payments will go up from $1,432 to $1,610,” said Joe Moshé, broker and owner of Long Island, N.Y.-based Charles Rutenberg Realty Inc. “That means you will be paying $178 more a month on a 30-year mortgage. Rising interest rates will negatively affect local real estate markets as we enter the spring buying season. With local real estate markets showing signs of recovery due to low inventories and increased demand, the question is by how much.”
In fact, mortgage rates already increased this past week in anticipation of the rate hike. As of the week ended March 10, the average rate for a 30-year fixed-rate mortgage was 4.46%, up from 4.36% the previous week, according to the Mortgage Bankers Association’s (MBA) Weekly Mortgage Applications Survey.
However, some experts said rising rates won’t have as much of an impact on home sales as people generally think:
“Reports have suggested, or surely will, that this rise in mortgage rates will be the demise of the housing market,” said Mark Fleming, chief economist for First American Mortgage Solutions, in a statement. “That’s just not so.”
“Yes, many existing homeowners will have a financial disincentive to sell because they would lose their lower than prevailing mortgage rates in doing so, the so-called rate lock-in effect,” Fleming said. “I have suggested that this is one of the reasons we see low inventories in most markets today, but it’s not as simple as that. We don’t act rationally. Even economists who, of all people, should know better.”
“More importantly, affordability remains high and our survey data shows that mortgage rates would have to be significantly higher to have any meaningful impact,” Fleming added.
“In terms of affordability, on Monday we released an analysis of affordability assuming the mortgage rate was 4.75 percent,” Fleming continued. “What did we find? Even at the higher mortgage rate, for the majority of markets a median income can purchase more than the median priced house.”
“Why is this? The house buying power that borrowers have, even with rates below five percent, still remains historically strong. It would take a significantly higher mortgage rate to significantly erode the real, house-buying power adjusted, price of housing.”
So, what would be the mortgage rate that dampens demand? Fleming said based on First American’s Real Estate Sentiment Index, “the mortgage rate would need to hit 5.4 percent, 1.2 percent above the current rate, before homebuyers declined to enter the market.”
“Among title agents and real estate professionals surveyed, 57 percent believe that Millennial first-time homebuyer demand will rise regardless of a mortgage rate increase,” Fleming said. “Rising rates are not expected to slow down demand this spring home buying season.”
The FOMC last raised the fed funds rate in December to the range of 0.50% to 0.75%. It was the first rate hike since December 2015, when the committee voted to raise the fed funds rate by 0.25%. What’s more, it was only the second increase since 2006.