Amid a surprisingly strong U.S. economic performance and persistent inflation, the Federal Reserve on Wednesday raised the federal funds rate by another 75 basis points, to 3.75%-4%, launching it to the highest level since December 2007.

The decision, expected by most Fed observers and the financial markets, is intended to further slow down the housing market. 

The Fed’s tightening monetary policy, which started in March, has resulted in a cumulative 375 bps hike: 25 bps in March, 50 bps in May, and four subsequent 75 bps increases in June, July, September and November. 

The Fed is hiking rates to rein in still-hot inflation, which hit 8.2% over the last 12 months, rising by 0.4% in September and 0.1% in August, according to an October 13 report by the Bureau of Labor Statistics. 

Increases in the shelter, food and medical care indexes were the largest contributors to the monthly seasonally adjusted all items growth. According to the BLS, shelter increased by 0.7% monthly and 6.6% in 12 months.

The Fed is also looking at the overall U.S. economic performance. GDP in the third quarter grew at a rate of 2.6%, breaking the negative GDP streak from the past two quarters.

Impact on the housing market

The Fed’s monetary policy has had a significant impact on the housing market in recent months, pushing mortgage rates to the 7% level and sending home sales on a downward spiral. 

“In the mortgage market, consumers who may otherwise be considering buying a home may choose to continue to hold onto their down payments, waiting to see if interest rates and/or home prices decline in the not-too-distant future,” Michele Raneri, TransUnion’s vice president of financial services research and consulting, said in a statement. 

Aside from rate hikes, the Fed’s moves can also impact the housing sector via the mortgage-backed securities market. 

“The Fed knows housing is in a recession, and higher mortgage rates will make things worse for the sector, so they’re not going to make that situation any worse than it is by selling off mortgage-backed securities,” said Logan Mohtashami, HousingWire’s lead analyst. 

Further increases expected

Further increases in the federal fund rates are expected for this year. The Fed’s next meeting will be held on Dec. 13 and 14 – and economists have started to discuss what will happen next. 

“The Federal Reserve is in a state where they need to figure out what to do next: they want a job loss recession and are seeing some weaker economic data, so they need to start talking about slowing down the rate hikes,” Mohtashami said. “Then the labor market is still staying positive for them, making their forecast for a job loss recession next year look off.”  

Mohtashami said that the Fed needs to take a stand on where they want to go with rate hikes and how strong they want the U.S. dollar to be.

“Do they want a soft landing where the economic pain is minor, or do they want to make the economy worse in the fight to destroy inflation?” he said.

Roger Ferguson, former vice chairman of the board of governors of the U.S. Federal Reserve System, believes the Fed will continue its tightening policy across the next three meetings, with a 50 basis points hike in December and two 25 basis points hikes at the start of 2023. 

“I fear that, if I’m wrong, it’s because I’ve underestimated (the rate hikes),” he said during the Mortgage Bankers Association (MBA) annual conference in Nashville. “Rates will probably stay there (at the peak) for much longer than people want. But at the end of the day, I hope for a short and shallow recession”.

According to Bright MLS chief economist Lisa Sturtevant, there are two basic near-term scenarios. First, if inflation remains stubbornly high, mortgage rates could climb to 8% or beyond in late 2022 and into the first part of 2023. 

Alternatively, inflation could ease, meaning mortgage rates could stabilize, though they will likely remain above 6% through the first part of 2023.

“If the Fed chair Powell continues to be transparent, investors will be able to digest those increases as long as they can see the Fed’s actions are making a difference,” Sturtevant said. 

The issue will be whether inflation continues to clock in above 8%, she said.

“That’s when people will start saying, ‘Look, we’ve been with you, ready to take the pain now to avoid pain later, but the pain we are taking now does not appear to be mitigating the pain later,” Sturtevant said.