Why house prices can remain high, complicating the Fed’s fight against inflation

Given that central bank monetary policy has helped push house prices up by about 20% annually, it makes sense that concerns have arisen about a possible sharp correction in house prices that could impact the economy.

Except that borrowers have already taken on trillions of low-cost, 30-year fixed-rate mortgage debt in recent years, leaving only about 10% of the $12.8 trillion adjustable-rate mortgage market, according to the Urban Institute .

That’s good for existing homeowners, as it dampens the kind of interest rate shocks that triggered a wave of subprime mortgage defaults in 2007-09 that sent home prices plummeting and exposed reckless leverage in financial markets that escalated into a global crisis.

“This is a different breed of borrower,” said Tracy Chen, a portfolio manager at Brandywine Global Investment Management, adding that she continues to invest in U.S. mortgage bonds due to higher underwriting standards over the past decade and richer yields lately became . “I’m a little insensitive to the consensus view that housing will collapse due to rate hikes.”

And even if a US recession is officially declared in this tightening cycle, historical data (see chart) shows that annual home price gains have only been negative once during downturns in the past 46 years – the 2008 dip that took years to recover from heal.

A hangover in housing

While the Fed can’t solve America’s long-standing affordability crisis, partly due to under-building after the 2008 crisis, its pandemic policies may have made matters worse for many first-time buyers.

That’s because a housing shortage benefits existing homeowners and landlords, but not renters, especially as food prices rose the most since 1979 in July. Shelter also continues to “anchor” core inflation, according to economists at Barclays, who called the 8.5%-per-year July CPI in a note to clients Wednesday shows inflation may be heading lower, or at least in the “right direction.” Direction”.

The Barclays team also expects housing inflation to “start easing in the autumn” but warned inflation could also remain stubbornly high due to high wages, a tight labor market and uncertainty around food and energy CL00,
-0.23%
Prices.

Read: ‘We have a feeling they’re rent cuts’: Tenants meet with Biden administration officials to bemoan steep landlord hikes

Scott Ruesterholz, a portfolio manager at Insight Investment, said he expects the CPI to stay in the 5.5% to 6% range, or the big “sticky” components that make up about 50% of the core CPI, housing, education and health care by the end of the year in comments via email.

“What we are going through is a mistake by the Fed,” Chen said over the phone. “They should have tightened up last year, and they’re still behind the curve.”

In addition to aggressive rate hikes this year, the Fed is also continuing to reduce its balance sheetwhich reached a record size of almost $9 trillion before the central bank began to mature more of its Treasury and mortgage bonds issued during the pandemic without reinvesting the proceeds.

“They are the largest holders of agency MBS,” Chen said of the central bank’s roughly $2.7 trillion portfolio of mortgage-backed securities. “This is a hangover from massive post-COVID stimuli.”

opinion: Inflation has not yet peaked because rents are still rising sharply

Stocks continued to rise with the S&P 500 index SPX on Thursday, a day after a sharp rally following July’s inflation report.
+1.73%,
Dow Jones Industry Average DJIA,
+1.27%
and Nasdaq Composite Index COMP,
+2.09%
with the highest closing prices since the beginning of May.