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Straight Talk
The Fed is sizing up the economy: all quiet on the Western Front

From our company chief economist, Selma Hepp

Following the Federal Open Market Committee’s (FOMC) two-day meeting this week, Chairperson Janet Yellen announced the decision to continue gradually raising interest rates, with another 25 basis-point increase to a target rate between 0.75 percent and 1.00 percent. This was a second increase in three months, with expectations of two more hikes later this year.

Yellen was resolute in her statements that any future increases will remain gradual in order to minimize the shock to financial markets. And indeed, the decision was largely anticipated and hence already built into the financial markets' response. One unanticipated market response was a drop in the value of dollar, which reflected analysts’ disappointment that the FOMC did not suggest more than two rate increases through the end of the year. Remaining on the rate-increase path that was previously suggested indicates that the Fed's position on the economic outlook is dovish.

In describing the current state of the economy, Yellen was rather confident and suggested that the country should feel good about the resilient and balanced economy, while noting that not all workers and sectors have benefited from the stronger labor market and wage growth. Nevertheless, Yellen and the FOMC remain optimistic about the global and U.S. economies, and they anticipate further improvements in jobs and wages.

The FOMC's decision to raise rates and its anticipation of future increases have been solely driven by recent economic and jobs data and not because of any anticipated policy changes by the new administration. Yellen pointed to continued uncertainty over timing and the exact parameters of tax reform or infrastructure spending. In fact, even though financial markets and business and consumer sentiment have been building in an optimistic outlook for the “new” economy, it is hard to tell if that will translate into increased consumer spending and thus a stronger economy. All in all, unless the Trump administration offers economic policy-specific changes, the Fed will continue to rely on mostly employment data when deciding on next steps. What do higher rates mean for the housing market?

The Fed’s interest rate increase is a double-edged sword: The move signals confidence in continued job growth but also means higher borrowing costs, which lowers housing affordability. And in the Los Angeles, where housing affordability is already a serious issue, further eroding affordability does not bode well for homebuyers using mortgage financing to purchase a home.

Recent historically low mortgage rates have allowed many homeowners to refinance with more favorable rates and terms. But as rates move higher, the incentive to sell is not as strong. Based on a CoreLogic analysis presented at the Sunset Seminar, only 11 percent of active mortgage balances have rates at 4.25 percent plus 100 basis points, which would incentivize owners to refinance their mortgage balances. Also, one in five of those borrowers is in default, leaving only about 9 percent with the incentive to refinance.

Additionally, as payment rates increase, the share of existing owners who will sell their homes also declines. For example, based on CoreLogic data, when rates fall by 1.5 percentage points, the share of home sellers who sold their home after 10 years of owning increased from 3 percent to 5 percent. An increase in mortgage rates could lead to a further tightening of the inventory of homes on the market and may constrain sales activity.


Selma Hepp is the Chief Economist and Vice President of Business Intelligence for Pacific Union International. Her previous positions include Chief Economist at Trulia, senior economist for the California Association of Realtors, and economist and manager of public policy and homeownership at the National Association of Realtors. She holds a Master of Arts in Economics from the State University of New York (SUNY), Buffalo, and a Ph.D. in Urban and Regional Planning and Design from the University of Maryland.

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