The Federal Open Market Committee (FOMC), the Fed’s monetary policymaking body, held the federal funds rate steady at a top rate of 2.5% at the conclusion of its March meeting. This was no surprise for financial markets, as this approach had been telegraphed by the Fed in January.
However, the Fed communicated two other elements that indicate that the central bank has adopted a more dovish monetary policy stance. Most importantly, the FOMC’s forward-looking projections now envision no rate increases in 2019 and a single rate hike in 2020. This is a remarkable downward revision for the Fed’s outlook, as the December 2018 projections called for the fed funds rate to be roughly 50 basis points higher than the current outlook over the course of 2019 to 2021.
The second change was an announcement that the Fed will slow the process of balance sheet reduction or quantitative tightening. The monthly drawdown in Treasuries will be cut in half in May and will conclude in September. The reduction of the Fed’s holding of mortgage-backed securities will continue, but these bonds will be replaced by an equivalent volume of Treasuries. On net, this action will slightly reduce upward pressure on long-term interest rates.
The economic backdrop for these policy changes, as described by the Fed, include a tight labor market, but slowing economic growth. Chairman Powell specifically cited slowing European and Chinese economic growth as macro headwinds for the U.S. economy. However, the Fed’s projections call for slowing U.S economy growth as well. The revised economic forecast, combined with ongoing “muted” inflation pressure, enabled the Fed to move toward a data-dependent pause with respect to additional rate increases.
The more dovish stance is a positive factor for housing demand, as it reduces upward pressure for mortgage interest rates. NAHB’s initial 2019 forecast, as presented at IBS, called for one hike in 2019 (mid-year) and the possibility of an additional increase moving into 2020. This forecast included the 30-year mortgage interest rate experiencing a gradual increase back to the 5% range going into 2020.
As a result of the Fed’s announcement, our next forecast update will include a reduced mortgage rate path. We had previously reduced our rate forecast due to our call for slowing growth for 2019 and, in particular, 2020. However, it is important to keep in mind that the reason for the anticipated change in Fed policy – softening economic growth headed into 2020 – means that the lower rate path will be accompanied by additional macro headwinds in terms of lower growth.
Nonetheless, the Fed policy announcement is a positive factor for housing demand, which clearly weakened during the second half of 2018 due to high housing prices (due to lack of resale inventory and supply-side, construction cost factors) as well as rising interest rates. While there is considerable policy work to be done to reduce the cost of adding inventory that improves housing affordability, the more dovish approach from the Fed will help housing markets in 2019.