Toward the end of last year, there were predictions that the Federal Reserve would cut interest rates several times; the number six was floating around. But at the moment, with inflation proving to be more stubborn than expected, the market is only pricing in one rate cut in September, according to Apollo Global Management’s chief economist, Torsten Slok.
“It’s quite a dramatic turnaround,” Slok said on CNBC yesterday.
He mentioned Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, who yesterday said: “Most people thought that we’d be in a recession toward the end of last year—that didn’t happen. Instead we have very strong growth. U.S. Consumers have remained remarkably resilient. The housing market has remained resilient. So I’m not seeing the need to hurry and do rate cuts. I think we should take our time and get it right.”
But he didn’t rule out interest rate hikes this year.
“I don’t think we should rule anything out at this point,” Kashkari said, suggesting the country has the “luxury” of waiting to see where inflation will go before making any decisions regarding interest rates.
However, Slok doesn’t expect rate hikes this year. Still, the fact that Kashkari even mentioned not ruling out interest rate increases shows inflation isn’t “coming down to 2% as quickly as the Fed currently thinks,” Slok said.
And housing is a key part of that. “Let’s not forget that housing has a weight of roughly 35% to 40% of the CPI index, depending on how you measure it,” Slok explained; the consumer price index is a measure of the average change over time in prices for goods and services. “So it means that housing is a really critical component for the Fed when they tried to achieve the 2% inflation target.” When the Fed hits its 2% target and prices are deemed stable, it cuts interest rates—although it can make cuts before too.
But as we already know, housing supply is very weak, in some areas more than others—while demand is strong: People need homes. But “the textbook would have predicted that when mortgage rates go up in the range of 7% to 8%,” demand would soften, but because there is so little supply, it hasn’t meaningfully. That’s reflected in the latest Case-Shiller numbers, which measure the monthly change in single-family home values. The data shows home prices rose 6.5% in March from a year earlier. It also happened to be the ninth all-time high for home prices in the past year. (Rents have flattened, but they’re still high.) Mortgage rates have fallen from their more than 20-year peak at slightly over 8%, but they’re still substantially higher than those of the pandemic. As of the latest reading, the average 30-year fixed mortgage rate came in at 7.34%.
Housing “still is quite a significant risk, that it could put upward pressure on inflation over the coming quarters,” Slok said, adding that Fed Chair Jerome Powell has been focusing on supercore inflation, which excludes food, energy, and housing, “in an attempt to say, well, housing we can’t really control. So let’s try to take that out of the equation and remove that from the index.”
But in the last few months, other components have begun to reaccelerate, he said. ”The tailwind to consumption, and in particular consumption services, is just really strong, and that’s the challenge that supercore inflation has also been moving higher.”
Housing is more challenging for the Fed to control because it can’t necessarily build more homes, but it can attempt to control broader consumption, he said. Still, that’s the challenge ahead for Powell and the powers that be. There are varying estimates on the number of homes we’re missing, although all are in the millions. Powell has said it himself, that the current problems we’re seeing in the housing market because of skyrocketing mortgage rates are short-term, while the real problem goes deeper.
“The housing market is in a very challenging situation right now,” Powell said in early March. “Problems associated with low-rate mortgage [lock-in] and high [mortgage] rates and all that, those will abate as the economy normalizes and as rates normalize,” he noted, referring to disconnect between homeowners with below-market rates and the current offering that’s somewhat led to existing home sales falling to their lowest point in almost three decades last year. “But we’ll still be left with a housing market nationally, where there is a housing shortage.”