As expected, the Federal Open Market Commitee (FOMC) raised its target for the federal funds rate by 25 basis points at the conclusion of its December meeting, marking the fourth rate hike for 2018. The increase brings the target range to 2.25% to 2.5%, which is considered the lower end of “normalized” monetary policy – neither accommodative nor restrictive. Surprisingly, the Fed retained its language noting “strong” economic growth, despite measurable weakness in recent months in leading sectors like housing and construction. That said, Federal Reserve Chairman Powell did refer to “cross currents” in markets as a potential nod to recent volatility, while prior statements indicated a move to a more “data dependent” perspective.
The Fed’s announcement did strike a slightly more dovish stance than prior policy announcements by revising down the number of expected rate hikes for 2019. Its policy projections (the “dot plot”) suggest two rate increases in 2019 and one additional rate increase in 2020. NAHB is forecasting just two next year with a pause in the summer and none in 2020 as GDP growth slows noticeably. Nonetheless, according to the Fed, inflation remains contained with the Fed projecting that the PCE measure of inflation will be near its target rate of 2%, on average, from 2019 to 2021. Underlining the small change in its policy stance, the central bank reduced its GDP growth forecast for 2019 to 2.3%. This downward revision is the reason for surprise with respect to retaining the “strong” verbiage noted above, at least from a forward-looking perspective.
The ten-year Treasury rate, the key variable for mortgage interest rates, increased to 2.86% prior to the Fed announcement and then declined to below 2.77% as markets digested the news. A lower ten-year rate means lower mortgage interest rates. The federal funds target rate has increased 225 basis points over the last three years, 100 basis points in 2018 alone. During this period, the Fed also began balance sheet reduction (that its plans to continue), which also places upward pressure on interest rates. The Fed could move to a more dovish approach by slowing balance sheet reduction, including sales of mortgage-backed securities.
During this period of monetary policy tightening, mortgage interest rates have increased approximately 70 basis points. The rise in mortgage rates in 2018, combined years of home price growth in excess of income growth, has reduced housing affordability to a ten-year low.