The Federal Reserve reduced the key, short-term federal funds rate by 25 basis points to a top rate of 2% at the conclusion of its September Federal Open Market Committee (FOMC) meeting. This was the second cut in 2019, partially reversing a set of increases enacted in 2018. The more dovish stance of the Fed is good for housing and home building, as forecasts for slow growth continue to be a headwind for additional construction growth.
The Fed also reduced the interest rate it pays on bank reserves. This was a technical move aimed to improve the ability of the Fed to target the federal funds rate in markets. The Fed’s ability to manage this rate weakened this week due a number of liquidity concerns. The Fed posses the tools to increase its efficiency in this area, but such short-term interest rates bear watching in the coming months.
There was notable disagreement among the members of the FOMC. Three Fed regional presidents voted no on today’s move, with two arguing for no rate reduction and one a supporter of a more aggressive 50 basis point reduction. This disagreement, in opposite policymaking directions, is reflective of the greater amount of economic uncertainty that currently exists. These three dissents were the highest number since 2014.
Despite the uncertainty, the Fed’s economic outlook remained relatively unchanged. The Fed characterized the labor market as “strong,” with economic activity rising at a “moderate” rate. This mirrors the home building economic perspective of a decent economic growth, ongoing labor shortages, and late cycle concerns over housing affordability. The Fed noted that “business fixed investment and exports have been weakening,” which is consistent with local housing market weakness seen in some parts of the U.S, such as a manufacturing-intensive areas. Household spending was described as rising at a “strong pace.”
Inflation was characterized by the Fed as “running below 2 percent” (its symmetric target), justifying its rate reduction in order to support full employment and price stability. Given these weak inflation pressures, we continue to forecast an additional federal funds rate cut during some part of the remainder of 2019.
The evolution of Federal Reserve policy over the last year 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 demand and home construction, while offering 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 estimate for generally flat conditions for new home sales and starts in 2019.