Housing is, to put it mildly, a huge problem for the Federal Reserve. According to the Case-Shiller Home Price Index, which measures 20 metropolitan regions, home prices appreciated 7.4% year over year in March – the highest annualized gain since 2022. Remember, housing represents a large — and important — sector of the inflation basket. The likelihood of inflation reaching the current 2% target seems more and more at risk purely because of shelter costs.
So how can the Fed get housing costs under control?
Housing costs, which include rent as well as money spent on “owner-equivalent rent,” make up roughly one-third of the Consumer Price Index (CPI), the basic measure of inflation that the Federal Reserve uses as proxy for price stability.
Home prices are not falling enough to help bring overall inflation down. This is because existing homeowners have mortgage loans well below current interest rates. These homeowners took out mortgages when interest rates were historic, pandemic-driven lows, and they are unwilling to sell. Even if they want to move, many are choosing not to because their replacement homes would be financed at much higher fixed rates. This has created an artificial hold on prices because so few homes are listed for sale.
Unfortunately, current housing cost dynamics suggest that the central bank’s old tools – changing interest rates and open market operations – aren’t adequate to combat the inflationary pressures that we’re seeing today. In other words, something bigger than the Fed needs for force housing prices lower.
Why the Fed Needs a Recession
That “something bigger” is a recession. If the Fed needs homeowners to list more properties for sale, it will need higher unemployment that forces owners to sell.
I don’t see any other way to stop this. To break inflation, we need to break housing. To break housing, we need a reverse wealth effect. This can either come from stocks dropping hard in value or an economic recession that causes a surge in unemployment. It’s time for a shock to the system.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
