Housing market is 'overly sensitive' to Fed rate hikes. Experts weigh in on what's next.

Exactly one year after the Federal Reserve began raising interest rates last March to slow down inflation – after slashing it to zero in March 2020 – home prices fell for the first time in 131 months.

With that, the longest price growth streak on record was halted as the median existing-home price for all housing types declined 0.2% to $363,000 in February from a year ago, according to data released Tuesday by the National Association of Realtors.

So far, the Fed has hiked the federal funds rate eight times to a range of 4.5% to 4.75%. On Wednesday, it raised rates by a quarter of a point as it pushes toward a projected target rate of 5.1%.

The pandemic housing market boom, which saw home prices rise by 40% over two years, began slowing in the second half of the year as mortgage rates doubled compared with the beginning of the year.

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How has the Federal Reserve’s rate increases affected the housing market?

“The Fed is actually very effective at speeding up and slowing down the housing market – almost too effective,” says Daryl Fairweather, the chief economist at Redfin. “If anything, the housing market has been overly sensitive to what the Fed has done with interest rates, both when interest rates were low and now when the interest rates are high.”

From the time the Fed indicated in December 2021 that it would be raising short-term interest rates to tamp down inflation – which had reached four-decade highs – it prompted a steady rise in mortgage rates.

Between the Fed announcement in December and its approval of a one-quarter percentage point increase on March 17 of last year, mortgage rates for a 30-year fixed loan had already risen to almost 4% in early March from 3.3%.

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Homebuyers flooded the housing market in the first quarter of the year as they tried to beat the expected mortgage rate increases, resulting in one of the most competitive quarters since the onset of the pandemic.

After reaching a record all-time high of $413,800 in June, home prices began declining on a month-over-month basis before recovering slightly in February.

Federal Reserve Board Chairman Jerome Powell speaks during a news conference after a Federal Open Market Committee meeting on Feb. 1.
Federal Reserve Board Chairman Jerome Powell speaks during a news conference after a Federal Open Market Committee meeting on Feb. 1.

“Prices would not have fallen if the Federal Reserve did not raise interest rates so aggressively,” says National Association of Realtors’ Chief Economist Lawrence Yun. “One casualty of the Fed’s policy, aside from the regional banks, is the loss in home values for some homeowners.”

If the Fed had done nothing, where would home prices have been today?

While experts agree that the Fed’s monetary policy slowed down the price growth last year, there are varied opinions on what would have happened if they had done nothing at all.

“I don't think the affordability actually would've changed, but it would have like been ripe for a bubble. If interest rates stayed low for too long, then a bubble would've formed in the housing market where once interest rates went up, it would've been a much harsher fall."

House prices were on a tear in 2020 and 2021 because of the demand-supply imbalance in the housing market, PNC senior economist Abbey Omodunbi says.

“We have seen a significant slowing in housing activity since the Fed started tightening monetary policy last year,” Omodunbi says. “House price growth would have accelerated if the Fed didn’t start tightening monetary policy.”

While it is true that the Fed’s rate hikes, which led to higher mortgage rates, slowed price growth, it’s not clear what the counterfactual would have been, according to Bright MLS Chief Economist Lisa Sturtevant.

“The goal of the rate hikes was to reduce inflation. Unchecked inflation would have also seriously eroded buyers’ purchasing power, so the fast pace of price growth could have slowed anyway,” she says.

Jeff Taylor, founder and managing director at Mphasis Digital Risk and board member at the Mortgage Bankers Association, agrees with that assessment.

If the Fed had done nothing and inflation continued to run rampant, prices still would have come down most likely due to a much faster recession and economic hardship, he says.

“When it comes to median prices of existing homes, it's most relevant for homebuyers to look at price trends versus the previous month and relative to the pandemic peak. February existing home prices of $363,000 were up $4,000 from January, but down $50,800 from the pandemic era peak of $413,800 in June 2022,” he says.

What effect will the fed rate change have on the housing market?

If the Fed raises interest rates, expect a more subdued spring housing market than originally anticipated at the beginning of the year, say experts.

Mortgage rates could be heading up again as the Federal Reserve Wednesday announced a 25-basis point increase, the ninth rate increase in the past 12 months, says Sturtevant.

"A half percentage point increase in mortgage rates increases the monthly payment of a typical homebuyer by more than $100," she says. "Elevated mortgage rates likely will lead to more softening in home prices."                                                                      

The national median home price declined year-over-year in February for the first time in more than a decade.

While higher rates could mean more price drops in the months to come, but don’t expect prices to fall dramatically. Low inventory continues to limit buyers’ leverage and sellers still have the upper hand in most markets.

Home sellers will have to make peace with the fact that they're going to trade the low interest rate on their current house with a higher rate on their next house, and they might not sell for the price they're hoping for, says Holden Lewis, Home and Mortgage expert at NerdWallet.

“Home buyers should accept that if they wait for interest rates to fall substantially, they might wait longer than they expect," he s

Fed hikes cause lots of headline noise, but mortgage rates are lower than they have been for quite some time, more than 1% from their 7.375% peak on Oct. 20, 2022, says Taylor.

“It is the daily trading of mortgage bonds – not Fed actions – that move mortgage rates,” Taylor says. “As bond investors get bullish seeing the Fed do its job to moderate inflation, mortgage rates will drop as lower future inflation makes bonds more valuable.”

And that is actually good news for homeowners, and as the Fed progresses on its inflation fight, mortgage rates are likely to drop more, he says.

“Prices dipped from the peak as higher rates resulting from the Fed inflation fight slowed home sales,” he says. “Prices rose slightly in February as rates dipped to near 6% in January.”

Swapna Venugopal Ramaswamy is a housing and economy correspondent for USA TODAY.  You can follow her on Twitter @SwapnaVenugopal and sign up for our Daily Money newsletter here.

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This article originally appeared on USA TODAY: Experts discuss how Fed rate hikes affected housing market past year