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Here’s why the Fed’s Rate Hike Will not Affect Housing

ratesAs 2016 begins, the jury is still out on what the effect of last month’s long-awaited federal funds rate increase by the Federal Reserve will be on the economy, and on housing in particular. Some analysts have expressed concern that the Federal Reserve’s monetary tightening will reduce affordability, raise mortgage rates, or otherwise reverse the gains that housing has made in the last year.

Those in the housing industry can rest easy in assurance that housing market strength acquired throughout 2015 will withstand the Fed's decision to raise the federal funds rate.

According to a commentary by Freddie Mac Chief Economist Sean Becketti on Monday, however, Freddie Mac does not share those concerns about the feared adverse effects of the Fed’s monetary policy on housing.

For one, he said, the Fed has committed to a gradual pace of monetary tightening because the central bank is aware that the U.S. economy is still fragile; “We take the Fed at its word and expect only a few modest hikes in short-term interest rates next year,” Becketti said.

Also, Becketti pointed out, the link is tenuous between the long-term rates (which includes mortgage rates) and short-term rates that the Fed controls.

In the mid-2000s, before the crash, mortgage rates hovered around 6 percent despite the fact that the Fed raised short-term rates for 17 consecutive meetings. Furthermore, increases in long-term rates will be limited by weakness in the global economy and a stronger dollar which will attract global capital flows to Treasury securities, Becketti said. The Fed will further be incentivized to moderate the pace of monetary tightening due to plummeting oil prices and the stronger dollar which will limit inflation.

“In spite of these headwinds, longer term interest rates will start to increase in 2016 as the monetary tightening starts to impact economic activity, but the increases in rates like the mortgage rate will be just a fraction of the increase in the federal funds rate and other short-term rates,” Becketti said. “However, even a modest increase in mortgage rates will reduce affordability, especially for first-time homebuyers and low-to-moderate income borrowers. This reduction in affordability may restrain house price increases at the lower-priced end of the market.”

A reduction in the Fed's Quantitative Easing (QE) Portfolio could result in an increase in long-term interest rates, but that does not fit with the Fed's public commitment to gradual monetary tightening. “We don't expect the Fed to shrink the QE portfolio until the latter part of 2016 at the earliest, and any significant reduction in the QE portfolio isn't likely until 2017,” Becketti said.

I'm While Freddie Mac is optimistic about housing for 2016, there is some uncertainty with regards to the broader economy, Becketti said. While the start of the Fed's monetary tightening indicates that the central bank believes the U.S. economy is on track, the post-Great Recession performance of the economy has been the weakest post-World War II. Also, real GDP growth is likely to be no more than 2.5 percent, and that is the best case scenario; this is well below the 3.2 percent annual GDP grown the economy has averaged since World War II.

About Author: Seth Welborn

Seth Welborn is a Harding University graduate with a degree in English and a minor in writing. He is a contributing writer for MReport. An East Texas Native, he has studied abroad in Athens, Greece and works part-time as a photographer.

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