Speculation was rampant in September that the Fed would raise the short-term interest rates, and they did not. Now, sentiment seems to be leaning heavily in the direction once more that the Fed will announce a rate increase on Wednesday. What is the difference between now and three months ago?

One of the big difference is that we’ve continued to have reasonably solid employment growth. The Fed takes a pretty close look at the monthly job numbers that come out from the labor department. The economy has added close to almost 2.9 million jobs over the last 12 months. The Fed needed to see some further assurance that economic growth is reaching a self-sustaining level, as measured by employment gains. We’ve continued to see those employment gains, and that’s new and positive information. It might be enough to convince the Fed that now it can raise short-term interest rates.

The other things the Fed looks at are the foreign exchange value of the dollar, international markets, commodity prices, global economic growth, and it’s a little more of a mixed bag. Global economic growth doesn’t necessarily look better than it did three months ago. The dollar remains fairly strong. Commodity prices, especially oil prices, continue to slip. The Fed may be concerned that if they raise short-term interest rates now, maybe that strengthens the dollar further and maybe the Fed is worried about how that might affect job growth in the U.S., especially for export-oriented industries. Now, with the much weaker oil prices, it means there could be a lot of layoffs in energy producing areas.

The Fed looks at all of these things. Some indicators show an improving economy, while others may be more questionable. They’re going to have to talk through those issues.

I think there is a good chance on Wednesday afternoon, we’ll hear that the Fed has decided to raise the funds target by 25 basis points. But if turns out they choose not to, I think we’re certainly looking at an increase in the first quarter of 2016.

If the Fed does raise the federal funds target rate by 25 basis points on Wednesday, what effect will it have on the housing industry?

If they raise the fed funds target, the most immediate effect will be on short-term interest rates. In other words, it’ll be important for those homeowners who have an adjustable-rate mortgage (ARM) or a home equity line of credit (HELOC), because those are the two instruments that are indexed through short-term rates. It’s very common for home equity loans to be indexed through a bank prime, and if you see the federal funds rate go up a quarter of a percentage point, we may very well see the bank prime go up a quarter percent. So those homeowners with a home equity line may actually be the first ones to actually see an increase in the rate. Over subsequent months, those homeowners with an ARM will see their rate finally adjust upward. Those homeowners with ARM have not seen an upward adjustment in many years. Those are the most immediate impacts.

The Fed has very indirect influence over the long-term fixed-rate interest rates. The Fed can set short-term rates and then the impact on long-term rates comes by how it affects all the intermediate rates. Let’s say short-term rates go up a percentage point in the next year. That would probably translate into some upward pressure on fixed-rate interest rates, but not a whole lot. At most, I would see them up about a half a percentage point between now and the end of 2016 for 30-year fixed-rate mortgage rates.

So how does that affect the market? It doesn’t affect anybody who already has a fixed-rate mortgage, because by definition, those mortgage rates are fixed and don’t change. But it will affect those consumers who would have been in the market applying for a fixed-rate loan. In particular, if we look at refinance and purchase money, those homeowners who would have been considering refinancing maybe now are no longer in the market to refinance if mortgage rates move higher. So what we would likely see in 2016 is a big drop in refinance originations compared with what we saw in 2015. In fact, since we are expecting the Fed to move at some point—if not Wednesday, then early in the first quarter—and we are expecting fixed-rate mortgage rates to go a little higher from where they are today, we are expecting refinance originations to fall by one-third in 2016 compared to 2015. So that’s a big drop in refi volume.

Another danger for the Fed is if they don’t act now when everyone is expecting them to, they’re going to start losing credibility.

For purchase money, we’re expecting what’s prompting the Fed action is that the Fed is feeling pretty confident that the economy is going to grow at about a 2.5 percent pace in 2016. That means the economy will generate at least 2.5 million jobs, maybe more, in 2016. That will put downward pressure on the national unemployment rate. We’re currently at 5 percent, so we’ll see it move below 5 percent. In that type of market, where incomes are beginning to rise, we’ll see home sales rising, even though there’s a little bit of an uptick in mortgage rates. The growth in jobs and income offsets the rise in mortgage rates, so we expect to see a little bit of a pickup in home sales.

So it’s the rise in home sales and the rise in home prices that we’re forecasting—about a 5 percent rise in national home price indices—that translates into purchase money originations rising in 2016. So we have two different things happening in the origination market. Refi volume falls by a third and purchase money rises by about 10 percent, according to our projections. Total single-family originations, which are the sum of refi plus purchase money, will end up declining by about 10 percent from 2015 to 2016 because of the big drop in refi.

How will it affect housing if the Fed doesn’t raise the rates on Wednesday, or will it have any effect at all?

It would be complicated if they don’t act and the economy appears to strengthen is that it starts to raise inflationary fears and expectations in the capital markets. That in and of itself can push up long-term interest rates even though the Fed hasn’t done anything. Long-term interest rates might rise because of capital market investors fearing that the economy is overheating, inflationary pressures are rising, unionized workers are going on strike and demanding higher wages . . . that’s the kind of psychology in the market that can lead long-term interest rates to rise even though the Fed hasn’t changed short-term interest rates.

The Fed can control short-term interest rates. They can guess where long-term interest rates are going, but they can’t control long-term interest rates. Long-term interest rates are affected in part by the inflationary expectations of investors in the marketplace. Suppose you’re an investor and you want to invest your money in mortgage bonds for the next 10 years, and you think inflation will be 2 percent per year over the next 10 years and you want to earn 2 percent above that to invest in mortgages. So you need a return of 4 percent. Suppose something happens and you think inflation is going to be at 3 percent per year. You think the economy is really overheating. You think inflation is going to be 3 percent but you still want to make your 2 percent return per year above that, so now you need to have a coupon or return of 5 percent to invest in a 30-year fixed-rate mortgage. That’s how inflationary expectations affect long-term interest rates.

Another danger for the Fed is if they don’t act now when everyone is expecting them to—especially now that the Fed has had a number of governors and the chair say “This era of near zero short-term interest rates will end soon”—they’re going to start losing credibility. Everyone was expecting them to do it in September, and prior to that, everyone was expecting them to do it in June, so everyone’s been forecasting that the Fed is going to raise short-term interest rates, and they haven’t. At some point, they’re going to lose credibility. If they don’t do it this time, I think it pretty much means they have to do it in the first quarter, unless something catastrophic happens to the economy.

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