What a week it has been in the economy. The federal reserve is still struggling to contain inflation and as a result increased the federal funds rate. After the announcement stocks roared back in a huge “relief” rally and mortgage rates fell. What do all these differing indicators mean for the economy and in turn real estate. Are the stock and bond markets correct in their interpretation of where the economy is heading?
Federal reserve raises rates .25%
The Federal Reserve raised interest rates by a quarter percentage point and penciled in an additional hike later this year, steps aimed at containing inflation that will test Chairman Kevin Warsh’s relationship with President Donald Trump.
“Today’s policy action will support a timelier return to the committee’s 2% goal,” officials said in a statement following the move Wednesday, referring to inflation. It was the US central bank’s first rate increase since July 2023. It cited elevated uncertainty due in part from geopolitics and omitted previous language that had attributed elevated inflation partly to supply shocks.
Mortgage rates fall when fed raises rates, why?
Mortgage rates in the US dropped for the first time in three weeks. Typically, as short term treasuries rise, longer dated securities along with mortgage rates would also rise. This did not happen.
The market was relieved that the federal reserve is focusing on inflation and this is basically a “relief rally” that the market has confidence that the federal reserve will actually do its job.
Are the stock and bond markets correct in their interpretation of the economy?
Unfortunately there is way too much optimism in the economy and the bond market is drastically underestimating the bumpy road ahead. Furthermore the stock market is pricing in a “soft landing” that will be near impossible to achieve. Below are three drivers where the bond and stock markets are showing undue optimism.
- Inflation stickier than market pricing in: after the announcement of the recent federal reserve rate increases, the stock market rallied basically pricing in that inflation will come under control with little pain from the higher rates. Unfortunately this misses the mark on how stick inflation is. Just as the federal reserve continued saying that inflation was “transitory” for the last two years the bond and stock markets have not gotten the message of how entrenched inflation really is. Every time I look at any business news there is a story about rising prices from consumer goods to electric companies and everything in between. It also doesn’t look like there is any end in sight to the huge government military spending or a resolution to the middle east conflict. None of these factors correct themselves easily which means the federal reserve will need to raise rates higher and longer than the markets are currently pricing in.
- Substantial stimulus still in the economy & more being added that will make fed job difficult: Currently congress and the president continue to increase stimulus in the economy from the 250 billion chips act to 400 billion for the build back better to billions of deficit spending. All of this money is entering a red hot economy which will keep demand and prices higher for longer than anticipated further adding to inflationary pressures and making the federal reserve’s job increasingly difficult as they work to decrease demand through higher rates.
- Too much market optimism: The market is pricing in a goldilocks scenario that is unlikely to come to fruition. There is no way we can “grow” the economy out of the deficit debacle we are in under any circumstances which means three items will/can occur rates will have to go higher, government spending will have to substantially decrease, or taxes will have to increase or some combination of the three. All of these items will be huge headwinds on the economy.
Real estate is in for a ride in 2027
Even with interest rates falling, the demand for real estate has declined at the same time inventories have also started to push higher. These factors are an economic recipe for price corrections. Look for nationwide prices to be off 10-15% in the next year or so and off considerably more in extremely hot pandemic markets Like Denver or Austin. How far prices fall will be dependent on how far the federal reserve must go in order to get inflation under control. Unfortunately I think it is going to be a lot farther than the market thinks which is why I assumed declines in real estate values.
What happens now to the economy and real estate with higher interest rates
There are conflicting indicators going on in the economy. When the federal reserve hikes rates, mortgage rates should also increase. Weirdly, just the opposite has happened. Bond prices have a similar story, as the federal reserve highlights inflation will take more rate hikes to tame, the bond market is now pricing in a slowdown in rate hikes before the hiking is even complete leading to declines in long term rates. Unfortunately both the stock and bond markets are pricing in a bit too much optimism.
Over the next several months, I expect mortgage rates to increase as the market finally realizes that even if inflation has peaked, it is not going to decline rapidly which will lead to further federal reserve increases as opposed to rate cuts that are anticipated next year. Furthermore stock prices have substantial downside risk as the economy slows considerably due to higher rates and profits become crimped.
Unfortunately the “sunshine” scenario the markets are currently pricing in will not last long as the market fundamentals are painting a drastically different picture. Look for real estate to continue slowing with corrections in pricing throughout the country and steeper corrections in hot Covid that got way ahead of themselves.
Additional Reading/Resources:
- https://www.cnbc.com/2022/07/28/gdp-q2-.html
- https://www.bloomberg.com/news/articles/2022-07-27/stocks-bonds-jump-on-glimpse-of-slower-fed-hikes-markets-wrap?srnd=premium
- https://www.bloomberg.com/news/articles/2022-07-28/us-mortgages-rates-dip-to-5-3-in-first-decline-since-early-july?srnd=premium
- https://www.wsj.com/articles/fed-raises-interest-rates-by-0-75-percentage-point-11658944935
- https://www.fairviewlending.com/interest-rates-surge-frightening-bond-market-change/
- https://www.fairviewlending.com/more-homeowners-now-underwater-what-markets-are-most-at-risk/
- https://www.bloomberg.com/news/articles/2026-09-16/fed-raises-rates-as-warsh-bucks-trump-to-contain-inflation
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
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