Fed Chair Calls Housing Market “Very Overheated”

Jerome Powell said he viewed the U.S. housing market as “very overheated” after the pandemic, and believes supply and demand need to get back into balance.

Powell spoke at a press conference on November 2 as the U.S. Federal Reserve Committee, which Powell chairs, raised rates 0.75 percentage points to fight surging U.S. inflation. That could raise mortgage costs further, after they have already risen substantially in 2022. Powell’s actions and comments were not positive for housing.

Lower Risk

Powell doesn’t see parallels to the great financial crisis because lending and credit standards for mortgages are now much higher in the Fed’s view than during the financial crisis, so Powell believes fallout from a weaker housing market for the broader economy market may be lower.

Fed Put?

Powell made clear that his main concern is managing inflation, and if anything, rather than looking to support asset valuations such as housing, stocks and bonds, Powell is far more focused on driving inflation lower. There’s not much evidence of the ‘Fed put’ today, which is the market term for how the Fed would step in and perhaps look to cut rates if stock valuations fell sharply. That may be bad news for housing too.

Powell may believe that lower asset valuations may be part of the solution to lower inflation currently, rather than a problem the Fed is seeking to remedy.

Given that rates may rise higher still over the coming months, that is not necessarily good news for the housing markets. We should note of course that future rate expectations are typically embedded in mortgage costs, so the Fed raising rates in line with market forecasts won’t necessarily cause longer term mortgage rates to correspondingly rise too much.

Further To Fall?

The challenge is that despite Powell’s bleak assessment, house prices have not fallen much yet. Yes, we’ve seen a few down months since the summer, but house prices remain up double digits on a year-over-year percentage basis on most housing indices.

In contrast, mortgage costs, which are a key driver of housing affordability have recently topped seven percent. That’s a level not seen since 2002 or earlier based on a 30-year mortgage costs. Houses are becoming far less affordable.

The End Of Low Rates?

A period of very low rates in the U.S. economy may be ending, and that’s not good news for housing. One hope for the housing market is that the Fed is perhaps now close to the top of the interest rate cycle, and maybe rates come down in 2023.

Still, even that view could be too optimistic, futures suggest some chance the Fed holds rates steady in 2023. Lowering rates may be some way off. The market currently views rates coming back to around four percent as among the more extreme outcomes for 2023. It more likely that short term rates spend most of 2023 around five percent based on market expectations.

Based on today’s comments the chance of the Fed supporting the housing market appear low compared to the priority of fighting inflation. If anything, the Fed may actually be looking for house prices come down. This is because housing costs are a large portion of the inflation index which the Fed wants to tame. Lower house prices may be what the Fed needs for lower levels of U.S. inflation.