Fed Raises Rates for First Time Since 2018 as Housing Shows Early Signs of Slowing

Key Takeaways:

• At its March 15-16 meeting, the Federal Open Market Committee (FOMC) voted to raise the target range for the federal funds rate by 25 basis points to 0.25-0.5 percent, the first hike since 2018. Additionally, officials appear poised to raise the federal funds rate by an additional 25 basis points at each of its six upcoming meetings this year, with three additional hikes penciled in for 2023, according to the committee’s median estimate. In his press conference, Chairman Powell stated that a runoff of the balance sheet could begin as soon as their May meeting and that the framework for running off the balance sheet would be similar to the 2018 balance sheet runoff, albeit at a faster pace.
• Retail sales and food services increased by a modest 0.3 percent in February, though January’s gain was revised upward by 1.1 points to 4.9 percent, according to the Census Bureau. Coming off a strong 7.3 percent gain in January, sales at automobile dealers were up another 0.9 percent in February. Furniture store sales and online retail sales each declined, falling 1.0 percent and 3.7 percent, respectively, though online retail sales have been particularly volatile in recent months. Surging oil and gasoline prices drove a 5.3 percent jump in sales at gas stations. Sales at restaurants increased 2.5 percent as COVID cases declined, their largest monthly gain since May 2021. Core retail sales (excluding food services, autos, building supplies, and gas stations) declined 1.2 percent.
• The Producer Price Index (PPI) for final demand of goods and services rose 0.8 percent in February and 10.0 percent over the year, according to the Bureau of Labor Statistics. The monthly gain was driven in large part by an 8.2 percent jump in energy prices. Final demand for services prices were flat over the month for the first time since December 2020 and were up 7.8 percent annually. Core PPI (less food, energy, and trade services) increased 0.2 percent over the month, its smallest monthly gain since November 2020, and 6.6 percent on an annual basis.
• Industrial production, a gauge of output in the manufacturing, utility, and mining sectors, rose 0.5 percent in February, according to the Federal Reserve Board. Manufacturing output rose 1.2 percent despite a 3.5 percent drag from manufacturing of motor vehicles and parts. Mining output ticked up 0.1 percent, while utilities output fell 2.7 percent as February’s weather returned closer to seasonal norms compared to an unseasonably cold January.
• Existing home sales declined 7.2 percent to a seasonally adjusted annualized rate (SAAR) of 6.0 million in February, the lowest level since August 2021, according to the National Association of REALTORS®. The number of homes on the market increased by a modest 2.4 percent to 870,000 but remains historically low. The months’ supply ticked up one-tenth to 1.7. The median sales price was up 15.5 percent compared to a year ago, a deceleration of three-tenths compared to January.
• Housing starts increased 6.8 percent in February to a SAAR of 1.8 million units, according to the Census Bureau. Single-family starts were up 5.7 percent to a SAAR of 1.2 million, and multifamily starts jumped 9.3 percent to a SAAR of 554,000. Both single-family and multifamily permits pulled back somewhat, falling 0.5 percent and 4.4 percent to SAARs of 1.2 million and 652,000, respectively.
• The National Association of Home Builders/Wells Fargo Housing Market Index declined 2 points to 79 in March, its lowest level since September 2021 after its third consecutive monthly decline. The index for single-family sales in the present fell 3 points to 86, while the index for single-family sales in the next six months dropped 10 points to 70, the lowest level since June 2020. The traffic of prospective buyers moved up 2 points to 67.

Forecast Impact:

The initial 25 basis point hike in the federal funds rate was in line with the revised expectation published in our March forecast, though the median estimate for future rate hikes this year came in higher than what we had anticipated. Further, we had previously expected the Fed to commence its balance sheet run off sometime in the second half of 2022, but Chairman Powell’s comments hinted at an earlier start. Therefore, we now expect monetary policy to be moderately tighter this year. This could weigh on housing activity via higher mortgage rates that would weigh further on affordability.

The February existing sales numbers were in line with our forecast of a near-term sales slowdown in part driven by a wave of purchase activity around the turn of the year that we believe was due to buyers pulling forward their purchase plans before an expected mortgage rate rise. We expect existing sales to decline further in 2022. Additionally, the NAHB survey showed a substantial 10-point drop in the index for new single-family sales in the next six months. Excluding the COVID-induced pullback, the last time this index fell so sharply was October 2018, when the Fed was running off its balance sheet and the 30-year mortgage rate was 4.83 percent, nearly a full percentage point higher than the year prior. This week, the Freddie Mac 30-year, fixed-rate mortgage was 107 basis points higher than a year ago. Still, given the historical relationship to mortgage rate changes, we wouldn’t expect recent rises in the mortgage rate to meaningfully dampen housing demand for some months (existing sales levels and the NAHB index for present sales remain well above pre-COVID levels). This is reflected in February’s housing starts, which, in line with our expectations, were robust. Further, though permits appear to have leveled off, they remain at a high level, also in line with our forecast of strong-but-plateauing new construction in part due to the ongoing lack of supply of existing homes for sale and the current outsized backlog of orders. However, during the Fed’s portfolio runoff and policy tightening during 2018, both permits and starts dipped modestly, presenting some downside risk to our current forecast.

The modest gain in retail sales, even when considering inflation, is supportive of relatively solid consumption in Q1 because of January’s upward revision, though we continue to believe a portion of January’s strength is due to abnormal seasonal adjustments. Still, the bounce back in spending at restaurants and bars is encouraging as future consumption growth will become increasingly reliant on a pivot of consumption away from goods and into services. Further, the modest 0.2 percent increase in core PPI would likely be more encouraging if not for the expected supply chain and energy sector disruptions caused by the Russian invasion of Ukraine and COVID lockdowns in China. We also note that rising prices for important building materials including lumber, steel mill products, and gypsum products may threaten new home construction. On balance, the PPI report is unlikely to alter our inflation forecast.

Nathaniel Drake
Economic and Strategic Research Group
March 18, 2022

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