Imagine a high-wire act performed without a net.  That describes the Federal Reserve’s effort to curb inflation without crashing the economy.  Success will bring applause and relief; failure, a brief downturn, at best, with a prolonged recession the worst case outcome. 

The Fed took its second definitive step along that tremulous wire in May, by approving a half-percent increase in its target Fed Funds rate. This followed the quarter-point hike in March that had brought the rate above zero for the first time in two years.   

Underscoring the Central Bank’s determination to tame an inflation rate (8.5 percent) that has reached a 40-year high, Fed Chairman Jerome Powell acknowledged the impact of rising prices on consumers and businesses. 

“We understand the hardship it is causing,” he told reporters, “and we’re moving expeditiously to bring it back down. We have both the tools we need and the resolve that it will take to restore price stability,” he added.

Success ‘Unlikely”

Achieving the soft landing the Fed hopes to steer won’t be easy, Powell noted.  Most analysts don’t think it will be possible.   Fifty seven percent of the economists responding to a recent poll said the Fed’s efforts will produce a recession compared with 33 percent who think that outcome can be avoided.

 “The likelihood is that things will be worse and last longer than in most models, meaning that the Fed’s ability to fashion a soft landing is highly unlikely. If it happens, it will be through sheer luck only,” Joel Naroff of Naroff Economics wrote in a note to clients. 

Responding to the Fed’s rate hikes, and anticipating more to come, mortgage rates have been rising for several weeks, now exceeding 5 percent for the first time in a decade.  Mortgage applications have been declining, as a result.  Prospective buyers, struggling to keep purchase costs within an affordable range, have begun turning to adjustable rate mortgages.  The Mortgage Bankers Association (MBA) reports  that ARMs represented nearly 10 percent of applications processed in early May, which doesn’t sound like a lot, but it is double the number reported just three months ago.

The combined impact of rising mortgage rates and rising prices (up almost 20 percent year-over-year in the February S&P CoreLogic Case-Shiller National Home Price Index) are exacerbating the affordability strains that many buyers were already feeling.

Affordability Strains

First American’s  Real House Price Index increased by more than 30 percent in February. That’s the largest  jump in this barometer’s 30-year history, and it has reduced the home purchasing power of consumers by almost 7 percent over the past year. Buyers purchasing a median-priced home with a 30-year loan are paying $550 per month more today than they would have paid for the same home a year ago, according to Realtor.com

Given those statistics, it is hardly surprising that  buyers are feeling less optimistic about the home ownership outlook. Fannie Mae’s Home Purchase Sentiment Index for March fell by 2.1 points to 73.2, as only 24 percent of respondents said this is “a good time to buy,” a record low for that component.  A Gallup survey reported similar results:  Only 30 percent of respondents agreed that  it’s a good time to buy a home, down 23 percent from a year ago and the first time the share has fallen below 50 percent since the poll began in 1978.

 “If consumer pessimism toward homebuying conditions continues and the recent mortgage rate increases are sustained, then we expect to see an even greater cooling of the housing market than previously forecast,”  Doug Duncan, Fannie’s chief economist, wrote in an analysis of the survey results.   

Signs of Cooling

Analysts agree that rising rates haven’t yet hit the housing market with hurricane force – but the winds are evident in current reports.  Existing home sales, new home sales and pending sales all declined in March, as did new single family home construction starts and permits for new construction.

Although prices are still rising, the rate of increase appears to be slowing – and sellers are beginning to respond.  Redfin reported price declines in the asking prices for 12 percent of its listings in early April, and that rate is increasing, Daryl Fairweather, Redfin’s chief economist, noted in a recent analysis.

“Price drops are still rare, but the fact that they are becoming more frequent is one clear sign that the housing market is cooling,” he said, illustrating “that there’s a limit to sellers’ power. There is still way more demand than supply, and buyers are still sweating,” he added, “but sellers can no longer overprice their home and still expect buyers to clamor at their door.”

In another sign that an overheated market has begun to cool, Redfin reports that fewer homes are receiving competing bids, a trend that Fairweather expects to continue as rising rates price more buyers out of the market. 

“That should provide some relief for people who can still afford to buy, as they’ll likely face fewer competing offers and may no longer need to offer drastically over the asking price in order to win,” he noted in a recent  report. “Unfortunately, the slowdown in competition won’t help those who have already been priced out of homeownership and are now grappling with soaring rental costs.”