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Housing Defies Fed’s Campaign to Control Inflation

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The breakneck pace of US home price increases accelerated even further last month, making the Federal Reserve’s task of curbing the worst inflation in 40 years even harder.

The seasonally adjusted median home sale price jumped 3.6% in April from March, the biggest increase in Zillow data dating to 2012. Inventory is starting to rise slightly, but it’s still so low that it’s vastly outstripped by demand, fueling housing appreciation. 

That’s extraordinarily frustrating for buyers faced with the combination of daunting prices and surging mortgage rates. Moreover, the inertia of housing — a large component of the indexes used to track inflation — means consumer prices are likely to stay higher for longer. That will dare Fed Chair Jerome Powell to raise interest rates even more aggressively. Increasingly, this looks as if it won’t end well.

Longtime stock and bond traders know it’s a fool’s errand to fight the Fed — to swim against the tide of tighter monetary policy — but that’s what the real estate market is doing, even as stocks and bonds have tumbled since the start of the year. If the pace of housing appreciation were to cool, that might allow for an orderly reset in the economy and the housing market — a “soft landing” in the parlance of the Fed. But the housing market is instead choosing defiance. 

The latest evidence is the renewed popularity of adjustable-rate mortgages, or ARMs, which offer lower initial rates than fixed-rate loans but leave buyers exposed to interest-rate risk later in the life of the loan. In the week ended May 6, ARMs increased to 10.8% of all mortgage applications, the highest percentage of total volume since March 2008. 

Buyers are finding it harder to make the math work on their home purchases, so they’re asking their brokers to find creative ways to get deals done. This isn’t some brewing systemic catastrophe — use of ARMs is still a tiny fraction of the volumes during the 2000s bubble — but instead of moving into the late innings of this housing cycle, these products help to extend the game.

Buoyant demand is combining with a near-record supply shortage that has no easy fix. Senior economist Jeff Tucker at Zillow wrote earlier this month that inventory may take until September 2024 to return to 2019 levels. Homebuilders are rushing to bring homes to market, but they’re facing continuing supply chain disruptions that make it hard to obtain materials such as windows and garage doors, and their stock market investors are rebelling and driving shares lower, fearing the new inventory will hit the market just in time for a sharp downturn.

All of this is a headache for the Fed, which has just embarked on a cycle of interest rate increases. Markets place a slim possibility that policy makers will have to bring the fed funds rate far above 3% to tame the worst inflation since 1970s, but a growing chorus of economists including former Obama administration adviser Jason Furman; Harvard University professor Ken Rogoff; and former Treasury Secretary Lawrence Summers think that 3% may be too low and that the rate may have to go to 4% or higher.  

Housing, of course, isn’t measured directly by the main price indexes and flows into inflation through rents and a category called owners’ equivalent rent, a metric that’s based on surveyed estimates of what people think their homes would rent for. 

Because of that, market housing prices feed into the consumer price index and personal consumption expenditure index with a substantial lag, which means today’s housing surge will be felt in inflation readings well into 2023, according to research from the International Monetary Fund’s Marijn Bolhuis, Harvard University’s Judd Cramer and Summers, the former Treasury secretary. “Even if home price increases were to stop, because we had seen such a run-up in home prices and because of the lagged structure of CPI, there were already large inflation increases baked in going forward,” Cramer told me Friday. “Not only has it not stalled, it hasn’t really started to decelerate yet by some private measures.”

There appears to be widespread conviction that home price increases will remain positive, even if — as expected — mortgage rates dampen the number of transactions. As the thinking goes, the large millennial homebuying demographic will provide a powerful tailwind to demand even after historic supply shortages begin to ease.

To be sure, this may prove the last gasp of the boom before the pace of appreciation cools to a pace that the Fed can tolerate. According to Jonathan Miller, president of appraiser Miller Samuel Inc., buyers may perceive the risk of even higher rates and be rushing to close deals beforehand. “There’s a tightening of the window of opportunity,” he told me. Spring is traditionally peak season for real estate, and a tepid summer could take some of the heat out of housing prices. But if this shows any sign of continuing, the market isn’t going to like what it unleashes upon itself: The more it goes up, the harder the Fed will have to push against it, risking a violent result for the entire economy.

More From Other Writers at Bloomberg Opinion:

• A Recession Won’t Be as Scary as It Sounds: Allison Schrager

• A Housing Market Slowdown Won’t Improve Affordability: Conor Sen

• The Fed Needs to Get Real About Interest Rates: Bill Dudley

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Jonathan Levin has worked as a Bloomberg journalist in Latin America and the U.S., covering finance, markets and M&A. Most recently, he has served as the company’s Miami bureau chief. He is a CFA charterholder.

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