submitted by
Uric Dufrene, Ph.D., Interim Executive Vice Chancellor for Academic Affairs, Sanders Chair in Business, Indiana University Southeast
One could argue that housing has perhaps been most impacted by current Federal Reserve monetary policy. With inflation at a forty-year high, the Fed finally began lifting the target Fed Funds rate, with the goal of suppressing demand and thus slowing down the rate of inflationary growth. Fed policy impacts mortgage rates, which bottomed out in early January 2021 at 2.74% and peaked in late 2022 at 6.81%.
The origins of the current housing market take us back to early 2020. The Covid pandemic threatened economic collapse, along with high levels of uncertainty. This was not the same as the Great Financial Crisis or prior recessions. There was not really a playbook. The Fed responded with a drop in the Fed Funds target rate from 1.75% in March 2020 to 1.25%. The rate would be lowered again to .25% by the end of the month.
In early 2020, the 30-year mortgage rate was approximately 3.6%. Looser monetary policy drove rates down to 2.8% almost a year later. Record low mortgage rates, along with significant government stimulus, combined to ignite home prices. In early 2020, the median selling price for existing homes, using National Association of Realtors data, was $272,800. Home prices peaked in June 2022 at a whopping $420,900!
As the old expression goes, hindsight is 20-20, and there is never a shortage of armchair quarterbacks. But any rational economic thinker can only wonder how the Fed could manage to make such a glaring policy error. In early 2020, the target Fed Funds rate was reduced to almost 0, and with the economic shock that nation’s economy was experiencing, you could make the case that this was necessary. For the next 18 months, the policy decisions are nothing less than bewildering. The target Fed Funds rate of .25% was held at that level all the way until March 2022. In early 2020, inflation, as measured by the CPI, was less than 1%. No doubt, the Fed feared the onset of deflation, a crippling phenomenon that devastates profits and magnifies the impact of any leverage. The looser monetary policy was very justified during this early phase of the pandemic.
After hitting bottom around May 2020, inflation then started to creep up again. Recall the supply chain issues and the gargantuan government stimulus that stoked demand. A year later, the CPI would be running at almost 5% inflation. Inflation was running hot, but the Fed refused to budge on the Fed Funds rate. In May 2021, the Fed Funds rate was still at .25%. By the end of 2021, inflation would be running at 7.2%. The Fed Funds rate was still at .25%. Inflation peaked June 2022 at 8.93%, but the Fed did not increase the target Fed Funds rate until May 2022, a month before hitting the peak in inflation.
We can see the impacts of these national decisions on local housing, although the impact has not been as severe as the national landscape. Over the first quarter of 2023, national existing home sales have dropped 38% compared to the first quarter of 2022. In Clark and Floyd county, home sales have only declined by 14.2% and 6.8% respectively. Home prices are on the decline nationally, as mortgage rate increases have snuffed out demand, and owners of low mortgages are reluctant to sell, thus impacting the supply of homes. The National Association of Realtor’s price data show that the average price of existing home sales is about flat from first quarter 2022 to the first quarter of 2023. This year- over-year comparison does not capture the June 2022 peak of $420,000. Prices have fallen fast since June but remain flat when compared to early 2022. In Clark and Floyd, home prices are up 5.7% and 15% respectively. Despite higher mortgage rates, local home prices remain in positive territory, likely due to the supply of homes available for sale. Homes available for sale have increased, with the months supply of inventory increasing to 1.6 and 1.4 for Clark and Floyd respectively. This is up from 1.0 and .8 from a year ago, but still at very low levels.
Locally, we do see the impact of federal policy on building permits, having a definite impact on activity. Clark County has always been the leader in building permit activity, given its role as the most populous county among the five Southern Indiana metro counites. In 2021, Clark County generated 1,626 building permits, with 716 of that level in 5+ units multi-family housing. In 2022, permit activity declined to 761, with only 154 in 5+ unit multi-family structures. So, building permits were cut by more than half in just a year. In Floyd County, building permits increased from 248 to 260, with multi-family units driving the increase from 2021 to 2022.
The Fed may be approaching the last rate increase at its next meeting in May. There is an outside chance that there will be a pause, but an increase of 25 basis points is likely. The rate of inflation growth is falling, with the last CPI headline number running at 5%. After the pause in rates, the Fed will hold for some time, keeping mortgage rates elevated. Some participants are pricing Fed rate declines later this year, but that is not certain. As the economy slows, this will push interest rates down, bringing further relief to mortgage rates.