Reasons for the Rapid Rise in Rates Keeping a Watch on Rising Rates The Outlook Moving Forward The economic drivers of these conditions are a nearly 40-year high for inflation, produced by too much Covid-era stimulus, supply-chain issues and global market disruptions, including the Russian war against Ukraine. While the Federal Reserve is now aggressively tightening monetary policy, via higher shortterm rates and balance sheet reductions of ultimately tens of billions of dollars worth of assets off its massive near-$9 trillion bond portfolio, it waited too long to act. The central bank’s call last year that inflation was “transitory” was a forecasting error. Further exacerbating the situation was a failure at the local, state and national levels to properly and effectively address the supply side of the economy, where inflation can be more efficiently fought. With the Fed falling behind the inflation curve, its leadership has now adopted a stark, hawkish stance to convince markets that it is in the inflation fight to win. As a result of the Fed’s aggressive monetary policy stance, interest rates have increased significantly in 2022 and particularly in recent weeks. Since the start of August, the 10year Treasury rate has increased from 2.6% to approximately 3.7%. And as the bond market decline gathered speed this week (a falling bond market often means rising mortgage rates), the 10-year Treasury rate briefly increased above 4%, the highest rate in 15 years. Rates then fell back on global issues and a focus on macroeconomic weakness at the end of the week. Additionally, mortgage interest rates have moved much higher because the spread between the 10-year Treasury and the 30year fixed rate mortgage has expanded because of market uncertainty, mortgage pre-payment risk, and the Fed’s plan to allow for tens of billions of dollars of mortgage-backed securities each month to roll off its balance sheet. The consequences of this credit market are clear to builders. Buyers are priced out of the market, especially first-time buyers. Profit margins compressed by residential construction market costs are under pressure from the need to adjust pricing and incentives to attract buyers. And a housing market that needs more supply to address a significant, structural housing deficit of about 1 million homes has to put this long-run project on hold as real-time market demand, weakened by declining housing affordability, retreats. Given this macro environment, 2022 will be the first year since 2011 to see a decline for single-family construction starts. The housing market, and other elements of the economy, are clearly slowing. The Fed, which many market observers now believe has adopted a stance that is too hawkish, should focus on the inflation data coming in the end of the year and slow its path of tightening to examine whether its policy is working to bring inflation down. And other regulatory and fiscal policymakers should do what they can to reduce regulatory cost burdens and other ineffective rules that artificially increase the cost of remodeling homes, building apartments and supplying for-rent and for-sale housing to the market. In the meantime, builders should continue to be cautious with respect to operations. The Fed has indicated that it plans to hold interest rates higher for longer. Unless a severe recession takes hold in 2023, interest rates are unlikely to ease until 2024. However, at that time, the housing market will rebound as interest rates fall back and a pool of frustrated, prospective home buyers comes back to the market in greater numbers. This means, unfortunately, the homeownership rate will decline in 2023, which places housing firmly on the political agenda heading into the 2024 elections. Page 18
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