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Don’t Bet the House on a Fed Rate Cut

Given the impact of housing costs on inflation, we expect the Federal Reserve to think twice before helping to boost home prices.

By Mike Rode, CFA
House made of folded U.S. currency.

Key Takeaways

Housing has a significant impact on broad measures of consumer inflation.

Despite recent weakness in home prices, underlying demand remains robust.

With lower rates likely to reignite housing prices and heighten broader inflation, we think it’s hard to see the Fed reducing interest rates in 2023.

The Federal Reserve’s (Fed’s) inflation fight has helped push mortgage lending rates to their highest level in two decades.

Spurred higher by the Fed’s aggressive rate-hike campaign, the average fixed 30-year mortgage rate has climbed from a pandemic low of under 3% to more than 7%. Mortgage rates haven’t been this high since 2002. Still, they’re a far cry from the historic peak of nearly 19% in 1981.

With borrowing costs at a 20-year high, it’s unsurprising that activity in the U.S. housing market has stalled. Orders for new and existing homes have plunged, ending a 10-year rally in U.S. home prices.1

Such weakness in a sector that accounts for a sixth of the U.S. economy complicates the Fed’s effort to pull off a “soft landing” — reducing inflation without tanking the economy. Moreover, given housing’s outsized influence on U.S. inflation measures, the Fed may resist cutting rates longer than investors, economists and homebuyers expect.

Could Housing Sector Weakness Give Way to ‘Panic’ Buying?

In 2019, the year before the pandemic started, U.S. homeowners listed about 1.2 million homes for sale every month. By last year, that figure dropped by about 70% to 350,000.2

Rising rates help explain the collapse in listings. Many homeowners have mortgages with rates below current levels, so they’re not eager to refinance at higher rates or trade up to better homes. Consequently, median home prices fell about 12% from their June 2022 peak, and existing home sales declined for 12 consecutive months before rising in February.

Rate cuts could help revive the housing market because low mortgage rates typically stimulate housing activity and increase home prices.

Pent-up demand from homebuyers who stayed on the sidelines, coupled with falling rates, could lead to “panic buying” from buyers who see a window to make an offer. Millennials who delayed purchasing, partly because they awaited lower mortgage rates, may be tempted to enter the market.3

Such a scenario would push home sales prices higher if this bears out. And even though stronger pricing would benefit homebuilders and related businesses, such gains would impede policymakers’ push to reduce inflation.

Why the Fed Likely Won’t Cut Rates Soon

The Fed has dual mandates: stabilizing inflation and promoting “maximum” employment. With unemployment near all-time lows, the central bank’s policy focus in the past year has targeted reducing the highest U.S. inflation in four decades.

It has made headway in lowering inflation’s trajectory. After peaking at 9.1% in June 2022, the U.S. Consumer Price Index (CPI) is trending lower. This improvement and recent concern about the U.S. banking system have caused many economists and analysts to suspect the Fed may start cutting rates later this year.

With consumer prices well above the Fed’s 2% inflation target, we think rate-cut expectations are premature. That’s because home prices, apartment rents and items related to residential housing account for almost half (49%) of the CPI’s core inflation calculation.4 Cutting Fed rates would help reduce mortgage rates, and falling mortgage rates tend to boost home prices.

Given housing’s substantial influence on CPI, we don’t think central bankers will risk taking action that might boost home prices. Therefore, we think the Fed will be reluctant to cut its benchmark rate, regardless of falling prices and weakness elsewhere in the economy.

The Fed has placed reducing inflation above broader economic concerns. If this remains the case, the housing sector’s crucial role in consumer price measurements should chill expectations of a rate cut anytime soon.

Mike Rode, CFA
Mike Rode, CFA

Vice President

Investment Director

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Trading Economics, “United States Existing Home Sales, February 2023; FRED Economic Data, Federal Reserve Bank of St. Louis, “S&P/Case-Shiller U.S. National Home Price Index,” February 2023.

FRED Economic Data, Federal Reserve Bank of St. Louis, “Housing Inventory: Active Listing Count in the United States,” February 2023.

Toll Brothers, Inc., “Q1 2023 Earnings Call Corrected Transcript,” February 22, 2023.

U.S. Bureau of Labor Statistics, “Consumer Price Index – March 2023,” News Release, April 12, 2023.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.