In a long-telegraphed move, the Federal Open Market Committee (FOMC) of the Federal Reserve raised its benchmark interest rate for the first time since December 2018, signaling the end of pandemic-era financial controls and dispatching the central bank’s toolkit to address growing inflation.
The FOMC, which sets Fed policy, announced after its Wednesday meeting that it will raise the federal funds rate by 25 basis points to a range of 0.25% to 0.50%. The committee added in its statement that it “anticipates that ongoing increases in the [interest rate’s] target range will be appropriate,” in line with earlier projections that 2022 could see three or even four hikes to the baseline rate.
The committee acknowledged that while the U.S. economy’s rebound has been solid, inflation has been widely problematic.
“Indicators of economic activity and employment have continued to strengthen,” the FOMC statement read. “Job gains have been strong in recent months and the unemployment rate has declined substantially. Inflation remains elevated, reflecting supply-and-demand imbalances related to the pandemic, higher energy prices and broader price pressures.
“The invasion of Ukraine by Russia is causing tremendous human and economic hardship. The implications for the U.S. economy are highly uncertain, but in the near term the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity.”
Looking at the forecasts released by the Fed accompanying its post-meeting statement, it’s clear that escalating inflation has changed the mindset of many within the central bank. Consider, for example, that the median forecaster this past December anticipated that 75 basis points of rate hikes would be the appropriate move in 2022. The most recent forecast, however, revealed that the median forecaster called for 175 basis points of rate hikes over the course of 2022 — an overall adjustment that would require the FOMC to raise rates at each of its six remaining meetings this year if it continues to issue increases of 25 basis points. Furthermore, the median forecaster projects another 75 basis points of increases next year.
If these predictions were to prove true, it would mean a jump of 250 basis points in the benchmark rate between the start of this year and the end of 2023. Jay H. Bryson, economist at Wells Fargo, wrote in commentary for the bank that more hikes in upcoming meetings seem evident, but given how volatile the global environment is of late, it’s difficult to predict past that.
“Unless the U.S. economy comes completely off the rails in the near term, Fed rate hikes at the next few meetings seem more or less like ‘sure bets,’ in our view,” Bryson wrote. “Thereafter, the committee may become much more data dependent. In our March monthly outlook, we forecasted that the FOMC would hike rates by 150 bps (including today’s meeting) over the course of the year, but today’s doubling-down on the hawkish pivot suggests that the risks to our forecast are tilted to the upside. That said, we would also point out that the outlook is unusually uncertain.”
Mike Fratantoni, chief economist for the Mortgage Bankers Association (MBA), said the rate increase was an appropriate first step.
“With the unemployment rate below 4%, inflation nearing 8% and the war in Ukraine likely to put even more upward pressure on prices, this is what the Fed needs to do to bring inflation under control,” he said. “The FOMC economic projections indicate slower growth and higher inflation than had been the expectation at their December meeting. Note that they do not expect to be back at 2% inflation until after 2024.”
The Fed also signaled that its balance sheet is set to shrink soon by passively reducing holdings of Treasurys and mortgage-backed securities (MBS). Per Fratantoni, the MBA will be an interested observer of how the FOMC decides to proceed.
“Although we anticipate that shrinking the balance sheet will begin this summer, we will be looking for details regarding the pace of the runoff and whether they would consider active MBS sales at some point to return to an all-Treasury portfolio,” he said.
As for how the rate increase will directly impact the housing market, it will be fascinating to see how the immediate bump — which is sure to nudge mortgage rates even further upward — will affect homebuyer psychology. Home sales of late also have been boosted by people rushing to secure home purchases and beat anticipated rate increases. But rising rates also cool demand and curb home-price growth, and while that’s already happened to some extent, the Fed’s actions should accelerate the process.
“Higher rates eat into the purchasing power of homebuyers,” said Danielle Hale, chief economist for Realtor.com. “The increase in monthly mortgage payments for a buyer putting 20% down on the typical for-sale listing is $290 higher than this time last year, with roughly half of the increase a result of higher rates and the other half a result of higher home prices. But individual experience will vary. Buyers purchasing more expensive homes or putting smaller downpayments will see greater cost increases.
“While these cost increases will make it more difficult for buyers to submit sky-high offers on for-sale homes, we expect that home sales will continue to grow at a relatively robust pace for two reasons. First, the housing market is already in a long-term shortage situation with 5.8 million more homes needed for families than were built over the last decade. Second, strong demand from young households — more than 45 million of whom are in the prime homebuying age range of 26 to 35 — will mean creative approaches to affordability challenges to meet the basic need for a roof over their heads.”