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How Will The Looming Federal Reserve Rate Hikes Affect Gilbert Housing

We at The Reeves Team have been getting a number of questions regarding the upcoming interest rate hikes and how it may affect the Gilbert real estate market. The federal reserve has been raising the federal funds rate at a rapid pace over the last year. In the last year there have been 3 rate hikes of .25% and it looks like its poised for two more rate hikes by the end of the year. Depending on your view this can be seen as a positive or a negative. The optimistic view is that the federal reserve feels confident enough in the economy to continue raising rates without hurting the economy to badly. Its true that our economy has been doing well for nearly a decade at this point and it has not shown any signs of slowing down. The pessimistic view is that 5 rate hikes in a year is to much to fast and could cause a pullback in the housing market or could even cause the next recession. The Reeves Team will take you through a look at some of the possibilities and technical jargon you may hear over the coming months regarding the federal reserve rate hikes and how it could affect the Gilbert housing market.  If you have not read Troy Reeves State of the Phoenix Housing Market it is also a great place to get his take on where we stand. 

Why do people believe the Fed will raise interest rates twice by the end of the year?

The federal reserve used to keep its decisions on interest rates a tightly guarded secret.  Nobody besides the central bankers knew if the rate would go up, down or stay the same until the announcement was made.  This policy changed in the mid-70’s after the federal reserve raised rates quickly from 5.75% to 13% and then back down to 7.5% in a relatively short period of time.  This caused confusion among the banks and the businesses who kept prices high because they didn’t know what to expect.  This stop-go monetary policy was replaced by what we now know as forward guidance.  The forward guidance provided by the central bankers has economists convinced that two more rate hikes are coming before the year end.  The president views the increase in the rate to be harmful to the growth of the economy and has forcefully spoken out against multiple rate hikes by the year end.  Having the president attempting to influence the fed rate policy is a break from tradition and many believe may in fact force the federal reserve to raise rates twice to show its autonomy from the executive branch.  Unless things in the economy change drastically it is reasonable to expect the federal reserve will increase rates twice by the end of 2018.

Can it really cause a recession if the Federal Reserve raises interest rates to fast?

The short answer is Yes.  We have historical examples of economic downturns that were created because of the federal reserve misjudging the strength of the economy and raising interest rates to fast. The most recent example is the recession in the 1980’s when interest rates were raised rapidly from 6% to 10% and created a recession almost single handed.  The most famous example of over-tightening by the federal reserve is the great depression. In fact in 2002 Ben Bernanke who was on the Federal Reserve at the time apologized for the federal reserves role in the great depression saying “Regarding the Great Depression, … we did it. We’re very sorry. … We won’t do it again.” So as a Gilbert homeowner or a potential homeowner  it is important to pay attention when the federal reserve starts to increase interest rates at a rapid pace.  The question we have to ask is if the economy is strong enough to bear these increased interest rates.  Currently the unemployment rate is below 4% from a high of nearly 10% in 2009.  We are also seeing strong growth in the housing market and stock market even though the market expects another two rate increases.  These indicators give us hope that we may not be ready for another recession in the short term.

Is it possible that interest rate rises could actually help the real estate market?

When the Federal Reserve decides to increase interest rates it is generally seen as a negative for the housing market.  It is seen as a negative because higher interest rates mean that more of a borrowers monthly payment will go to interest.  When interest rates go up, potential homeowners purchasing power goes down.   As potential homeowners can afford less home, sellers will often need to lower their prices to accommodate the reduced purchasing power.  There are a couple of reasons why this is not always the case.  First off, the Federal Funds Rate is not always as closely tied to the aver 30 year mortgage rate as most people would assume. 

As you can see from the chart above the federal funds rate and the 30 year fixed mortgage are loosely correlated but they are no where near identical.  You can see the funds rate rose dramatically from 2004 to 2006 and then dropped substantially in 2008 all while the 30 year fixed interest rate remained relatively steady. The second reason that interest rate rises could actually increase home values is FOMO.  FOMO or fear of missing out is the phenomenon that occurs when buyers feel like if they do not get in now they may never be able to get in.  As you can see from 2004 to 2006 the Federal Funds Rate was actually increasing at a dramatic pace while the housing boom was occurring and home values were rapidly appreciating.  By now we all know that was not the only thing that caused the market to run up and subsequently crash but it does show that its possible to have price appreciation while the federal rate is increasing. 

If the rate hikes do cause a downturn in the housing market how bad could it get?

It is hard to believe that he housing crash and the great recession are nearly a decade old at this point.  While its been nearly 10 years it was such a big event that it is still fresh in most peoples memory.  So most home owners and home buyers are aware of just how bad prices can crash when they do go down.  While we remember how bad it was last time, it is important to remember that the circumstances have changed dramatically and we are not in the same place we were 10 years ago.  While interest rates were rising in 2008 when the financial crisis occurred, the crash can be attributed more to the subprime mortgage epidemic and the lack of solvency for major financial institutions.  Banks have been careful not to recreate the same issues that caused the crash last time.  If the federal reserve does raise rates to quickly and the economy and housing is negatively affected, it is unlikely to be as dramatic and can hopefully be corrected more quickly than the previous crash.  

Its also important to not that home prices had a dramatic spike before the crash in 2008.   As you can see from the chart above the price of homes went parabolic starting in 2004 and ending in 2006.  Then there was a huge sell off and over correction in the market that ended in 2009.  Since then the price of homes have normalized and are currently much closer to where they should have been if they continued the trend before the massive run up in 2004.  So while the rise looks dramatic from 2012 to 2018 it is important to keep in mind that home prices were dramatically oversold before they began to bounce back. 

What is the yield curve and what happens if it inverts?

Currently there is a lot of talk about the yield curve and how it can be an indicator or a potential recession.  It is important to note that just because the yield curve inverts does not mean we are due for a recession. With that being said an inverted yield curve has preceded the last 7 recessions so it is certainly something to keep your eye on.  So what is a yield curve? 

To put it simply, a yield curve is the return you get for purchasing bonds depending on the length of time before their maturity.  Typically if you purchase a bond for a shorter amount of time you would expect less return on that investment.  As you can see from the chart currently the yield curve is not inverted, you will “yield” more from purchasing a 30 year bond than you will for purchasing a 1 year bond.  However this curve is flattening and if interest rates continue to rise we could see an inversion of this curve.  This is something to keep an eye on as it has accurately predicted the past 7 recessions.  However, each time is different with a unique set of circumstances and history doesn’t always repeat itself, but it does tend to rhyme.

Conclusion

So we at The Reeves Team have thrown a bunch of information at you.  Hopefully you have learned a lot and will now be able to more accurately understand the relationship between the Federal Reserve Rate and the Gilbert Housing Market.  However, you may still be asking yourself what does it all mean?  Is now a good time to buy a home? Or sell my current home?   While there are headwinds that are coming for the housing market, we are in a much better position than we were before the crash in 2008.  If there is a pullback in the market it will likely be much smaller and shorter than the previous pullback.  It is also not certain that the market will pull back at all, we could continue to see sideways price movement or even sustained growth. It is unlikely we will continue to see the 12 to 15 percent increases year over year we have been seeing in the Gilbert market over the next year or two.   While there is sure to be a lot of news and information around the market in the next few months, take everything with a grain of salt.  We still have a great economy and more people than ever want to live in the Gilbert area.