Fed’s rate strategy stymied by stubborn housing cost inflation

The Federal Reserve is facing questions about its ability to tame one of the largest drivers of inflation: the cost of housing.

Housing costs, measured as both rental costs within the consumer price index (CPI) and as mortgage rates, are one of the most interest rate-sensitive sectors of the economy, generally getting more expensive as rates go up and cheaper as rates go down.

But with the Fed now expected to keep rates higher for longer, a reprieve in shelter costs, which constitute a major portion of monthly expenditures for U.S. households, could still be a ways away.

Consumers remain hobbled by housing costs

Americans spend about 30 percent of their income on rent, according to research from Moody’s Analytics published over the summer, a record threshold initially reached last year.

Moody’s has described Americans as “rent-burdened,” arguing in April that “rent-to-income levels remain uncomfortably high.” In 2021, 20 million households that pay rent met the 30-percent income threshold and were “cost burdened,” according to the Census Bureau, an increase of about 1 million households since 2019.

“If you look at the consumer price index, the big contributor to high inflation is the shelter, both rents and owner-occupied rents,” Claudia Sahm, founder of Sahm Consulting and a former Federal Reserve economist, told The Hill.

“The increases in shelter costs have absolutely slowed down in the past six to eight months, but they take time to work their way through. … Frankly, we’ve gotten surprised at how long it’s taken and how bumpy it’s been.”

Fed faces pressure to cool down housing market

Inflation has been coming down over the past year as the Fed has been raising rates, falling to an annual rate of 3.7 percent in September from a high of 9.1 percent in June of last year.

But annual housing inflation is still around 7 percent and accounts for the vast majority of all the inflation left in the economy.

The CPI’s shelter index accounted for more than 70 percent of the total increase in all items less food and energy, the Labor Department reported earlier this month.

“The Fed needs to study the housing market at this moment very carefully, because it’s at the point where it really starts to have an effect,” Sahm said. “[Fed Chair Jerome Powell] pointed to the housing market, because it’s clear that activity there is slowing down.”

While one of the fastest Fed tightening cycles on record has driven housing costs higher, an underlying shortage of affordable, multifamily housing has also dogged the housing market.

Realtor.com puts the shortage at between 2.3 and 6.5 million homes.

Can Powell tame property owners?

Tenants-rights activists say that focusing on the financial system or even the physical supply of housing is shortsighted and neglects the fact that landlords and property owners simply have too much power over tenants, allowing them to drive up prices at will.

“Federal housing policy is designed in a way that prioritizes the industry that profits from providing housing, rather than the people who need homes,” argued the Homes Guarantee advocacy group, which wants to see rent control limitations placed on all national housing subsidy programs.

The group also wants to see the Biden administration enact a national tenants bill of rights to protect against profiteering in the housing sector as a matter of public policy.

Powell said Wednesday that effects of housing costs on the economy were becoming “significant.”

“We’re getting reports from housing that the effects of this could be quite significant,” he said, noting that activity in the housing sector has flattened out and remains well below levels of a year ago.

Housing remains in the Fed’s sights

The Fed’s latest anecdotal survey of the U.S. economy is riddled with complaints about the affordability of housing.

“Housing affordability remained extremely low, and rents remained high in the current period. Requests for assistance with housing and utility bills continued to dominate 211 [hotline] requests in New Jersey and Pennsylvania. Roughly one-third of all requests in the two states were related to housing,” the Federal Reserve Bank of Philadelphia reported in the October “Beige Book,” the Fed’s monthly summary of regional economic conditions.

Rental and home ownership affordability as measured in September by the Department of Housing and Urban Development are both near 23-year lows, while month-to-month house prices were near 20-year highs.

“Rising rents and a shortage of affordable housing continued to impact low- and moderate-income households’ ability to secure housing. Moreover, some landlords stopped accepting housing choice vouchers in order to get higher rents in the open market,” the Cleveland Fed observed.

Despite elevated levels, shelter prices have been declining in recent months, with owners’ equivalent rent falling to 7.1 percent in September off a high of 8.1 percent in April.

The shelter component of the CPI also stands at 7.1 percent, off a March peak of 8.2 percent.

But that descent has been touch-and-go and has been a source of surprise for economists.

“It was clear this was coming, but last month forecasters were surprised; it didn’t come down as much as we’d expected. We don’t know exactly how the translation goes between new rents and the CPI,” Sahm said.

“We know the direction of this, but exactly when it happens is not clear, and shelter makes a bigger contribution to the CPI in general, so it’s not like this inflation is just going away.”

Thirty-year fixed-rate mortgages are near their highest levels in 23 years, at 7.86 percent.

“The impact of higher rates continued to be felt across both purchase and refinance markets. Purchase applications decreased to their lowest level since 1995 and refinance applications to the lowest level since January 2023,” Joel Kan, Mortgage Bankers Association vice president, wrote in a note Wednesday.

Economists sound the alarm on bond yields

Soaring bond yields, which are closely correlated with mortgage rates, especially for longer-term maturities, were also a concern for economists watching the outcome of the Fed’s meeting.

“Powell’s focus on persistent conditions, especially regarding the rise in Treasury yields and the near-8% mortgage rate, suggests that the Fed is closely monitoring the broader economic indicators,” Jon Maier, head of investments at financial firm Global X, wrote in an analysis.

Despite the high cost of housing, home ownership rates for moderate earners rose to some of their highest levels ever during the pandemic, boosted by trillions in stimulus sent out by both the Trump and Biden administrations.

In the first quarter, the homeownership rate for Americans earning less than the median family income of $74,580 hit 53.4 percent, a number surpassed in recent decades only during the second and third quarters of 2020, when the government was helicoptering emergency cash onto households during the pandemic, according to Census Bureau data.

Powell stressed Wednesday that Fed bankers had not yet made up their mind about future rate hikes or whether Fed policy was now sufficiently “restrictive.”

“We’re not confident at this time that we’ve reached such a stance. We’re not confident that we haven’t, but we’re not confident that we have,” Powell said.