At the conclusion of its May meeting, the Federal Reserve held the key, short-term federal funds rate steady, with a top rate of 2.5%. The decision was unanimous and widely expected, with members of the Federal Open Market Committee agreeing that while economic growth conditions remain “solid,” inflation pressures remain anchored.
In fact, the Fed’s preferred inflation gauge, the core PCE index, registered a 15-month low in March, with just a 1.6% year-over year gain. The Fed’s target for inflation is 2%. The Fed nodded to the expectation that this dip in inflation is transitory, and our forecast agrees with this approach. A tight labor market and rising material costs will increase inflation pressure as the economy moves into 2020. Nonetheless, the recent downside miss on inflation, remaining below 2%, is the reason that the Fed has adopted a more patient approach with respect to normalizing monetary and future rate hikes. We do not expect another federal funds rate increase until, at the earliest, the end of 2019.
For housing, the more dovish perspective of the Federal Reserve is an important reason why mortgage interest rates have declined from late-2018 cycle highs. Given that the housing market faced a 10-year low for housing affordability last Fall, the Fed’s approach is a net positive for future housing market activity and offers an offset (but only a partial one) for rising construction costs. These costs are limiting housing inventory, particularly at the entry-level market. Moreover, higher production costs have caused housing affordability to decline in recent years and are the primary driver for NAHB’s call for generally flat conditions for new home sales and starts in 2019.