When the Federal Open Market Committee begins its two-day meeting on Tuesday, it ought to consider whether its policies aimed to bolster housing may be having negative side effects.
With the market for new and existing homes red hot, the rationale for subsidizing the mortgage market has largely passed. Indeed, the Fed’s policies may be hurting home affordability as much as they’re helping.
The Federal Reserve’s policy-setting panel is all but certain to maintain its current ultra-easy policy stance of near-zero short-term interest rates and heavy securities purchases to continue to spur the economic recovery from the steep pandemic downturn. There will be no updated Summary of Economic Projections or “dot plot” of the FOMC members’ guesses of the federal funds target rates.
However, the FOMC will discuss when to reduce the current pace of monthly securities purchases from the current $80 billion of Treasuries and $40 billion of agency mortgage-backed securities. Fed Chair Jerome Powell has said the central bank isn’t even “thinking about thinking about thinking about” tapering its bond buying. (Although he may have added another “thinking about” that I might have missed.)
The rationale is that the labor market is far from recouping the jobs lost in last year’s steep contraction. Even a string of robust payroll gains like March’s 900,000-plus pop would take many months to close the shortfall of 8.5 million jobs.
As for the Fed’s other mandate, it wants inflation to run somewhat above its nominal 2% target for a considerable period to make up for past shortfalls so that prices average that 2%.
But as colleague Lisa Beilfuss points out, the Fed seems to be ignoring the effect that rising food and housing costs may be having on inflation psychology.
The Fed dismisses much of the price rises as “transitory.” There is some justification for not reacting to jumps in agricultural commodities that feed into the cost at the butcher counter. And as the saying in the futures pits goes, the cure for high prices is high prices, which ration demand and spur new supplies.
In the case of housing, however, the Fed is helping to feed the buying frenzy in many markets, which has been supercharged by the effects of the pandemic and the desire to have room to work at home.
In the market for securities issued by agencies such as Fannie Mae and Freddie Mac, yield spreads over comparable Treasuries are already the tightest since 2012, according to Walt Schmidt, head of mortgages at FHN Financial. That’s translated into strong activity in the market for nonagency mortgages, which are generally larger than the limits on so-called conforming loans that the agencies purchase. According to Bank of America, non-agency activity is up a robust 19% from 2019, a better comparison than versus the Covid-19-depressed levels of 2020.
Strong housing and mortgage activity argues against the Fed effectively subsidizing a sector that is near bubble territory. According to the Home Price Appreciation Index from the American Enterprise Institute, prices are up 12.6% in the 12 months through March, a doubling of the pace from a year ago. Among various markets, Phoenix was up 17.7% while the smallest gain was in the New York metro area with a 7.0% rise.
Those soaring house prices don’t get captured directly in gauges such as the consumer-price index. Instead, the CPI tries to estimate housing inflation through something called owners’ equivalent rent, an estimate of what homeowners would pay to rent their own house.
Using this nonmarket measure as a guide to inflation is dangerous, Joseph Carson, former chief economist at Alliance Bernstein, wrote on LinkedIn. Relying on this contrived measure understates housing inflation and the Fed’s impact on it, Carson said.
New Zealand’s central bank, the first to adopt inflation targeting in the late 1980s, recently became the first to take into consideration the impact its policies have on its superhot housing market.
Other central banks’ actions also are indirectly helping to inflate U.S. housing costs. Last week, the Bank of Canada said it would scale back its securities purchases, which further fueled the Canadian dollar’s rally to a three-year high against the greenback. A higher loonie translates to further upward pressure on already soaring lumber prices in the U.S.
“Monetary policy that supports the extension of easy money when house prices are rising at record rates makes no sense. It’s one thing to misread the tea leaves of an asset bubble, but it’s another thing to be the enabler,” Carson writes.
One way to stop inflating home prices would be for the Fed to reduce its purchases of mortgage-backed securities. If that suggestion sounds familiar, it’s because Peter Boockvar made it in this column back in December.
Perhaps the FOMC will eventually listen.
Write to Randall W. Forsyth at [email protected]
