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Higher mortgage costs cool home sales as Fed sends interest rate higher

Persistent high inflation is driving the Fed to raise the federal fund interest rate to slow the economy. That rate, in turn, influences consumer and business lending rates, which are now heading higher. (Shutterstock)
  • The Fed got aggressive on Wednesday in attempt to cool persistent inflation;
  • Mortgage rates, already slowing home sales, are expected to continue to rise; 
  • Michigan’s unemployment rate could climb close to 5 percent with additional planned rate increases 

The Federal Reserve on Wednesday met widespread expectations by accelerating its inflation-fighting tool: Raising interest rates on the money banks loan each other. 

The benchmark federal funds rate will increase by 0.75 percentage points, with increases totaling 3 percentage points this year, taking it to its highest level since 2008. The increase followed a unanimous vote by the Federal Open Market Committee, the Fed’s policymaking arm.

But other economic data is also hammering expectations. Ongoing high inflation, falling new housing starts, rising wages and — so far, a positive — low unemployment combine to signify that the Fed’s increase is happening amid fast-changing dynamics outside of monetary policy.

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As a result, the Fed “​​anticipates that ongoing increases … will be appropriate,” it said Wednesday. The federal fund rate could reach 4.6 percent in 2023.

The interest rate hike means consumers can expect to pay more for many forms of borrowing, including mortgages, auto loans and credit card debts.

The changes already are affecting home sales, with the median price of a home in the U.S. falling 6 percent to $389,500 in August from the $413,800 record set in June, the National Association of Realtors said Wednesday.

Businesses that rely on lines of credit or are highly leveraged will also feel the impact.
 

 
 

Signs of a struggling economy persist. And how high interest rates will go and what that means for the nation remains difficult to predict. 

Estimates for this quarter’s gross domestic product, the measure of the nation’s economic activity, dropped to 0.3 percent following housing news this week. A decreasing GDP can signal a shrinking economy or signs of a recession.

Further, the Dow Jones Industrial Average, which fell 9 percent in the past month, dropped 1,200 points last week with news that inflation remained hot. 

“It’s pretty obvious that the Fed needs to do more. How much will ultimately be enough? It is a million-dollar question. It’s very uncertain at this point,”  Daniil Manaenkov, an economist with the University of Michigan, told Bridge Michigan. 

“It’s not out of the realm of possibility that the Fed may have to raise rates much higher than what the markets expect right now.” 

Effects of rate increase

In March, the Fed raised rates up a quarter of a percentage point to 0.5 percent, the first increase since 2018. The Fed increased rates 0.5 percent in May before stepping up the pace and making back-to-back increases of 0.75 percent in June and July. This month’s meeting was the first since then. 

The increase-rate maneuvers are part of an effort to slow the economy and lower inflation back to 2 percent. A goal the Fed expects to reach by 2025.

However, the consumer price index, the measure of inflation, rose 0.1% in August, totaling 8.3 percent over the past year.

In August, officials warned the inflation slowdown could accompany “some pain.” And Fed Chair Jerome Powell on Wednesday said that pain will come from “a softer labor market,” higher interest rates and slower GDP growth. 

The targeted slowdown will likely increase national unemployment by 15 percentage points, jumping from 3.8 percent to 4.4 percent in 2023 and 2024. Michigan’s unemployment rate would likely increase from 4.2 percent to just above 4.8 percent.

Cutting inflation could break a “vicious cycle” that would slow recovery, if inflation leads to faster wage increases, which in turn would drive more inflation, Manaenkov said .

During a press conference in Washington, D.C., Powell said Americans “are really suffering from inflation” and seeing their wage growth evaporate through routine spending. Lowering it, he said, will set the nation up for a stronger labor market again.

“I wish there was a painless way to do that,” he said. “There isn’t.”

While rate increases could cut consumer spending, Manaenkov said business investments could change financial projections but may not be affected in a meaningful way. 

If an interest rate hike signals imminent recession, Manaenkov said, that will have more bearing on business spending than the rate itself. 

Housing impact

The interest rate increase is clearly having an impact on the housing market, U-M’s Manaenkov said, notably in home building.

U.S. Census Bureau data released on Tuesday shows residential building permits dropped by 10 percent in August from a month earlier. And the seasonally adjusted rate of 1.5 million was 14.4 percent below August 2021 figures. Specifically, single family permits dropped by 3.5 percent from July to August.

At the same time existing home sales fell 0.4 percent across the U.S. in August, the seventh straight month showing a decline, according to the National Association of Realtors. Sales have dropped about 20 percent since August 2021, NAR said.

​​“The housing market is showing an immediate impact from the changes of monetary policy,” NAR Chief Economist Lawrence Yun said Wednesday in a statement.

Mortgage rates climbed to 6 percent for a 30-year loan for borrowers with very good credit early this month. This week, that rate went to about 6.58 percent.

According to the Michigan Association of Realtors, home sales were down nearly 13 percent in July from the previous year, yet prices increased about 12 percent during the same period, averaging $273,661 so far this year. Michigan data was not available for August. 

Dan Elsea, president of Real Estate One, told Bridge in late August that the state’s Realtors expected a slowdown based on fewer showings scheduled that month. 

National year-over-year housing starts were flat, while completions were up 5 percent. 

“Manufacturers have a ton of homes started,” Manaenkov said. “And now those are accumulating. … New construction is likely to drop off further. And construction is exactly what contributes to the gross domestic product.”

In Michigan, home construction fell 10 percent in July and about 15 percent in August, said Bob Filka, CEO of the Home Builders Association of Michigan. 

While that leaves builders unsettled, the state’s market for new construction is less based on speculative building than other parts of the country, Filka said. That means the inventory gluts that could be coming in high-growth areas may not affect Michigan.

So far, he said, the state’s builders are “all very busy still” even with some people canceling projects due to higher interest rates. Just as big of a problem in the home-building industry is the lack of supplies, which also is curtailing construction.

“There’s still a demand,” he said of new homes in the state. “And there’s still definitely a need.”

 

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