Employment, Inflation, and Interest Rates
Tricky balance will have major implications for the housing market in the months to come
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Employment, Inflation, and Interest Rates
I talk to many real estate agents on a weekly basis, some of whom have become quite good friends. For all of them it has been a year unlike any other, and not just because of the pandemic. In fact for anyone who has a job that touches the real estate market even tangentially including title attorneys, appraisers, home inspectors, and yes even bankers like myself, the real estate frenzy over the past year has led to an unprecedented surge in work. This has been a boon to many while leading to burnout for others. Regardless of whether someone has been riding high or barely hanging on amid the onslaught of work, among practically everyone with whom I speak there is a perpetual pondering of when this will all end and perhaps a longing to return to the comparatively modest and more manageable pre-pandemic levels of activity.
As an aside, with regard to real estate agents, while it is nice to work on commission in an environment of abundant transactions, I have to think that the current working environment is challenging. Unlike a normal 9:00 to 5:00 job, a real estate agent is always on, frequently doing showings and fielding phone calls, emails, and texts on weekends and all hours of the day. Buyers are particularly stressed due to limited inventory and fast-moving sales, and it cannot be easy to be a real estate agent right.
By all accounts the current real estate boom still has some legs. While it will eventually end and the timing is hard to predict, there are two major variables that those in the housing market either as consumers or professionals should be mindful of that will dictate a lot of what will happen over the coming months. These variables are employment and inflation and the key is how they impact interest rates.
The Employment-Inflation-Interest Rate Triumvirate
The housing boom over the past year has been driven by several factors including improving consumer confidence, stimulus funds that have strengthened household finances, a steady move of people out of renting in the cities to owning in more rural areas, and, of course, my favorite topic of late, the rising cost of lumber, which has made building a new home more expensive.
But beyond all of these factors, an overarching driving force behind the recent frenzy has been that interest rates have remained at historically low levels for a prolonged period of time. Consider this chart that shows the average interest rate on a 30-year fixed home mortgage over the last fifty years:
The average 30-year fixed rate as of the beginning of June 2021 is 2.95%, which is really low! Buying a house with a mortgage that carries a 2.95% interest rate fixed for thirty years is a lot more viable than buying a house with an interest rate of, say, 7.11% as it was twenty years ago in June 2001.
Interest rates in the United States are largely controlled by the Federal Open Market Committee, which meets throughout the year to guide the interest rates that banks charge their customers and the Federal Reserve, which influences interest rates through monetary policy and by raising or lowering the federal funds rates, which is the interest rate that banks can borrow from the Fed itself.
But the Fed does not set interest rates in a vacuum, it has twin goals: to promote strong levels of employment and to limit inflation. If the Fed thinks employment is too weak it will keep interest rates low in order to spur economic activity. This is the situation we have been in for the past year as the Fed has been concerned that low levels of employment due to the COVID-recession have represented structural weakness in the economy.
But as noted above, the Fed is also mindful about inflation. The Fed has a stated goal of keeping inflation to an annualized rate of 2.00%. If inflation runs too high, the Fed will hike interest rates in order to dampen economic activity and keep prices for consumer goods in check (Author’s note: stay tuned for a deeper dive on inflation in a future article and make sure you’re subscribed to receive it).
The goals of promoting employment but limiting inflation can sometimes run counter to one another, which makes the decisions the Fed makes extremely difficult and also closely watched. There is an entire cottage industry around predicting what the Fed will do because even small adjustments in rates make a huge difference to investors, businesses, and industries as a whole with implications for both the stock market and the political landscape.
The Current Picture
The economy is in a weird place right now. The monthly jobs report that was released on June 4th showed 559,000 new jobs, which may seem like a strong number, but economists were projecting 675,000 new jobs. The New York Times described it as a “decent-but-not-great” number. So the Fed has to be mindful that employment numbers are not as strong as they would like them to be as we emerge from the COVID-recession.
However, the specter of inflation lurks. In April, the Consumer Price Index increased by 4.2% over the year before, the largest increase since September 2008. Granted, this is a comparison with April 2020, which was the very beginning of COVID-related lockdowns when prices were already softening, but the robust inflation number is still something to keep an eye on.
The Fed is now therefore in a tricky place when it considers its dual mandate to promote full employment and limit inflation to an annualized rate of 2.00%. Keeping interest rates low should spur economic activity, which would promote employment gains. But keeping interest rates low also runs the risk of the economy overheating due to rising prices (i.e. inflation). This worry extends to the housing market, especially when considering that the last recession in 2008-2009 was caused in large part by a housing bubble.
The Fed has stated in its public communication that it is more mindful of employment at this point than inflation and that it expects inflation numbers to level off over the next few months. For much of 2018-2020 inflation was running below 2.00%, which provided ample justification to keep interest rates at or near historically low levels. The next few months will provide a real test, however, to see if inflation does level off. If employment does not come back as strong as the Fed expects yet inflation continues to rise, the decisions on what to do about interest rates will become all the more difficult.
Back to the Housing Market
So what does this all mean for the housing market? To be fair, interest rates are not the only driving factor in homebuyers’ decisions on when to buy and how much to pay, but they are a key variable for sure. Once interest rates do rise (and inevitably, they will), it is likely to have a damping effect on the housing market as people will not be able to afford as much home. Some people will decide simply not to buy if the cost of borrowing is too high for them.
For now, it seems the that Fed has no plans to raise interest rates anytime soon. We might be at these levels for the next 12-24 months, which could give the current housing frenzy some legs to keep running.
What potential homebuyers and sellers as well as other people in the housing industry like realtors, homebuilders, and bankers should be watching closely are the monthly jobs reports to see if employment gains continue and at what magnitude. But they should also be watching the monthly CPI reports for an understanding of what is happening with inflation.
The inflation report for May is scheduled to be released on June 10th at 8:30 am. The eyes of many an analyst will be on that report for an indication of whether the April inflation report was an aberration or whether concerns about inflation are actually taking root. If inflation takes off, the Fed will be tasked with difficult choices about what to do with interest rates in the face of still-weak employment yet rising costs. These decisions will have far-reaching impacts throughout the economy including on the housing market and are important to monitor especially if you are in the real estate market in any way either through your work or as a potential buyer or seller.
Ben Sprague lives and works in Bangor, Maine as a V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com. Follow Ben on Twitter, Facebook, or Instagram and subscribe to his weekly newsletter by clicking below.
Weekly Round-Up
Here are a few things that caught my eye this week plus some further reading on today’s topic:
The Bank of England is monitoring the U.K. housing boom and its potential implications for inflation: https://www.theguardian.com/business/2021/jun/01/bank-of-england-monitors-uk-housing-boom-as-it-weighs-inflation-risk-dave-ramsden-covid
The Cleveland Fed has a quick explainer about how the Fed thinks about inflation: https://www.clevelandfed.org/en/our-research/center-for-inflation-research/inflation-101/why-does-the-fed-care-get-started.aspx
Business Insider has an article out about how 64% of Millenials actually regret buying their home, with the most common reasons being high maintenance costs or buying in the wrong location: https://www.businessinsider.com/millennials-homeowners-regret-buying-home-housing-market-2021-6
Odeta Kushi shares data about how wages for construction jobs are spiking amid roaring demand and a tight labor pool:
The rental market in Portland, Maine is tight, with concerns growing about Air BNB’s and other short-term rentals pulling housing inventory for workers, families, and long-term residents off the market:
The ESPN Daily Podcast tells the story of how the background vocals in Marvin Gaye’s iconic “What’s Going On” were voiced by two players on the Detroit Lions. Marvin Gaye himself actually had a workout with the Lions and wanted to play for them, but he didn’t quite have the talent: https://www.espn.com/radio/play/_/id/31502571
Maine DOT shares some data showing a spike in visitors on Memorial Day Weekend compared to 2020, but lagging 2019, which was a particularly robust year for tourism in Maine. I’m guessing the poor weather in Maine on Memorial Day Weekend this year did dampen traffic a bit and if the weather had been nice we would have been closer to 2019 numbers.
Every time I go back to Fenway Park, I am amazed at how much the area has changed. The Boston Globe features a story about even more changes could be coming: https://www.bostonglobe.com/2021/06/03/business/massive-project-would-dramatically-change-streets-around-fenway-park/
Pants with buttons are making a comeback at L.L. Bean:
A Final Word
I want to give a shout-out to the Maine Youth Leadership organization, which puts on an annual seminar each spring for high school sophomores around the state of Maine. I attended this seminar myself as a sophomore at Bangor High School twenty-one years ago, and I was honored to return yesterday (by video) to keynote a speech about leadership and community involvement. Thank you to MYL for hosting me and thank you to the students and staff at the New England School of Communication for putting it all together. They run a great operation!
Have a great week everybody. Thanks for reading. If you enjoyed today’s article, please consider sharing on social media or forwarding the email to others to help spread the word.
Got news tips or story ideas? Email me at bsprague1@gmail.com.