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How The Fed鈥檚 High-Stakes Inflation Fight Hit The Hot Housing Market - YouTube
Channel: CNBC
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The Covid-19 pandemic caused
chaos in the housing market with
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prices skyrocketing inventories
dwindling and bidding wars
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reaching epic stakes.
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Housing in the burbs is red hot
because of the pandemic. But
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there's so much demand that
there's not a lot left to choose
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from.
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It's actually very hard to get a
mortgage even though rates are
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low.
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Inflation is a real worry...
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Then came record inflation which
drove the price of everything
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higher. It's impacting decisions
about how they spend their
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money. We at
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the Fed understand the hardship
that high inflation is causing.
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The US Federal Reserve's, though
is waging an intense fight
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against rising prices using
interest rates as its primary
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weapon to fight inflation.
Mortgage rates not only surged
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to the highest level since 2000.
A side effect of raising
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interest rates, though is higher
mortgage rates. What's more,
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the Fed now owns 2.7 trillion in
mortgage bonds part of its plan
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to prop up the financial system
when Covid first started, and it
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began selling them in June. So
what is the Fed's fight against
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inflation mean for the red hot
housing market?
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What the Federal Reserve is
doing right now is they're
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raising short term rates. That
would be the federal funds rate.
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This is interbank lending.
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The interest rate broadly
differs depending on what you're
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talking about. So your interest
rate for government bonds is
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very different from your
interest rate on your mortgage,
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which is very different from
your interest rates for credit
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cards, which is different from
your interest rate on car loans.
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But what really anchors all of
them is the 10 year government
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bonds in the US that interest
rate and that's the anchor
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because that is the ultimate in
safe haven asset that really
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anchors the entire market and 10
year government bond yield or
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interest rate is really based on
the Fed funds rate. So we're the
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central bank is setting short
term rates.
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The Federal Reserve and Mark
committee raising the funds rate
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by 75 basis points.
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The Federal Reserve raised short
term interest rates by 75 basis
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points on June 15. And that was
a big move.
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So when the Fed hikes its policy
rate, it affects a whole bunch
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of other rates in the economy.
And so variable rates for
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mortgages are anchored on short
and long term interest rates and
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the short term rate, which
affects the long term rate is
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all set by the Fed. And so if
the Fed is raising the policy
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rate, that means that anybody
with a variable mortgage is
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facing higher interest costs on
their mortgage. And so that
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means is the Feds tightening and
hiking interest rates, they're
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also making mortgages more
expensive, that should cool down
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the housing market. That is a
big part of the point. So
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mortgage backed securities are
basically a series of mortgages
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that are on a bank's balance
sheets that are sort of bundled
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and repackaged and sold off.
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Mortgage-backed securities are a
relatively small part of the
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Fed's balance sheet Treasuries
are still the lion's share, more
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than 80%. The fed's influence
over housing through MBS
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purchases is complicated. It's
partly direct. The fact that
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they're buying bonds means
there's a smaller quantity,
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which has a direct impact on
interest rates. But it's mostly
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psychological. That is, when the
Fed announces a significant
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buying programs, the market
starts to anticipate
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particularly pension funds and
insurance companies. These are
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bond investors who need both
very safe assets and very long
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maturities. So these are natural
buyers of mortgage-backed
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securities. And they immediately
start to worry about their
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ability to get those bonds at
decent interest rates in the
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future. So they step up the pace
of their borrowing. And because
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of that, when the Fed simply
comes out and announces a
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borrowing program, you'll often
see decline in mortgage interest
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rates of half a percent to a
full percent within a couple of
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months even before the program
begins.
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With the Fed now, saying it will
do an additional $15 billion of
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purchases of mortgage backed
securities today, that's on top
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of 32 billion it was already
going to do.
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When the Fed bought
mortgage-backed securities in
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the financial crisis. It was
very different from when they
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bought them during the pandemic,
although I suspect the logic at
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the beginning of the pandemic
was based on the logic of the
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housing crisis. During the
housing crisis, literally
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thousands of mortgage lenders
went out of business. They were
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actually highly levered
themselves. Many of them had
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huge exposure to the mortgage
market. They lost an enormous
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amount of money, they had margin
calls, and they disappeared.
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Fannie Mae and Freddie Mac,
which are absolutely central to
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the US As housing market, this
is the primary place where
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mortgage loans are converted
into mortgage-backed securities.
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They also had tremendous
exposure to the mortgage market.
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And it turns out, they had a
tremendous amount of leverage as
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well, they had to be bailed out.
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They are continuing the process
of significantly reducing the
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size of our balance sheet.
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Fed began to shrink its balance
sheet on the first of June this
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year.
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So it could cool the housing
markets. In theory, that's
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what's supposed to happen. In
practice, we don't really have
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much evidence of that. There was
the argument that the real
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estate market in the US was
overheating, already long before
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the Fed started rolling off MBS
mortgage backed securities from
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its balance sheet. And so there
was an argument that actually
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the Fed should prioritize
getting rid of mortgage backed
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securities over getting rid of
government bonds, for example,
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because you know, the housing
market was really overheating,
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partly because the Fed was such
a big player, and was creating
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demand for mortgages.
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If the Fed stops buying MBS
altogether, I think it should be
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a relatively small impact as
long as fixed income investors
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are comfortable with the idea
that mortgage rates are at their
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high.
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An important thing to remember
about the housing market is that
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housing can bring the economy
up. And housing can also
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contribute to a slower level of
growth. When people buy homes,
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they go out and spend the money
elsewhere in the economy. And
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when housing starts to slow,
some of that spending starts to
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slow.
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It is essential that we bring
inflation down if we were to
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have a sustained period of
strong labor market conditions
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that benefit all.
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The Fed is fighting inflation in
a way that we have not seen
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since 1981. In the last 45
years, any time recession
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signals began to flash, if the
Fed was hiking rates, they
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stopped. After a considerable
pause if recession warnings
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continued to flash they eased.
We have been told repeatedly by
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Fed officials, they're not going
to do that this time. In fact,
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Jay Powell told us that the
bigger mistake would not be
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causing a recession, it would be
failing to control inflation.
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The worst mistake we could make,
would be to fail. It's not an
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option. You know, we have to
restore price stability, we
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really do. Because everything
it's the bedrock of the economy,
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if you don't have price
stability, the economy is really
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not going to work.
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I think the likelihood of
recession, probably before the
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end of this year is extremely
high. And I think even if we
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have a recession, the Fed will
continue to hike. I cannot
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imagine under those
circumstances that we don't have
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some kind of correction in the
housing market.
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