Eye on the Economy Tightening Monetary Policy Bringing on Downturn

TIGHTENING MONETARY POLICY

Bringing on Downturn

The Federal Reserve further tightened monetary policy at the conclusion of its June meeting. Surpassing prior expectations, the Fed raised the federal funds target rate by seventy-five basis points. The Fed also committed to reducing its balance sheet, including net sales of mortgage-backed securities by $35 billion a month when fully phased-in. As a result of these moves, mortgage interest rates are closing in on 6% and will continue to climb as further tightening is expected throughout the year.

Despite the lack of resale inventory in the housing market, these higher rates — combined with rising construction costs (up 19% year over year, despite softening lumber prices) — are taking a toll on home builder confidence. In June, the NAHB/Wells Fargo Housing Market (HMI) fell two more points to a level of sixty-seven. The HMI has now fallen six straight months, and the traffic component has fallen below the key breakeven level of fifty for the first time since the summer of 2020.

Taken together, current economic and policy data indicate a housing downturn is underway. NAHB is forecasting a hard landing for the economy, with a recession in 2023. Although this will not involve a financial crisis, as the Great Recession did, it will mean declines for housing data and rising unemployment until the inflation threat has passed.

The ongoing bad news for inflation is the immediate trigger for current conditions. Inflation reached a fresh 40-year high in May, with the CPI up a painful 8.6% year over year. Economic policy needs to focus on improving the supply side of the economy by bringing down energy, transportation and material costs. Without such policy, the Fed is left to do all the work of fighting inflation, and the Fed’s tools are crude: Raising rates slows demand and has an outsized impact on interest-rate sensitive sectors such as housing.

Despite these medium-term macroeconomic headwinds, there remains a housing deficit in the United States. This means as the economy exits this period of higher inflation and a recession in the coming quarters, it will be the housing and home building sector that will recover and expand first. An aging housing stock will also support demand for remodeling activity, and as mortgage interest rates rise, the demand for rental multifamily and single-family housing will remain solid.

–NAHB Chief Economist Robert Dietz