What a week it has been a new Covid variant has emerged while at the same time, the federal reserve announced they are retiring the word “transitory”. The stock market dropped and treasury yields increased. What does all the recent news mean for real estate? Will inflation also drop with the new variant?
Federal reserve drops the term transitory
The U.S. central bank should consider accelerating the winding down of its large-scale bond purchases at its next policy meeting in two weeks amid a strong economy and expectations that a surge in inflation will persist into the middle of next year, Federal Reserve Chair Jerome Powell said on Tuesday. He also acknowledged that his preferred term for describing inflation as a likely passing phenomenon – “transitory” – should probably be “retired,” suggesting policymakers would make a more concerted effort to rein in price increases in the months ahead.
What does the Federal reserve change in tone mean for interest rates?
Powell came off as much more hawkish than many were assuming given the variant risk,” said Ben Jeffery, interest rate strategist at BMO Capital Markets in New York. “He said now is the time to kind of abandon the transitory characterization of inflation and said that maybe a conversation about tapering earlier than previously assumed might be appropriate.”
There is no doubt interest rates will be increasing faster than anticipated with the market now pricing in two rate hikes mid/late next year. As interest rates rise (treasury yields), rates on credit throughout the economy also rise from credit cards, car loans, to mortgage rates.
Omicron variant rears its head and could make matters worse
At the same time Powell is announcing the more hawkish policy at the federal reserve, the Omicron variant is rearing its head. Here is an interesting article published by Duke University economics professors. Here is what one of the professors predicted on inflation:
“But it may also prolong and postpone the eventual recovery of the supply chain. So I think there’s bad news for the longer term. We were hoping that the supply chain issues that were feeding some of the inflation would get resolved quickly. But with the rise of Omicron one of the things it could do is both suspend production in different parts of the world and continue to gum up the supply chain even worse.”
How will Omicron and inflation influence real estate values?
There are three factors that will influence where real estate values head from here:
- Inflation reducing purchasing power: Although wages are increasing, pretty much everything else is increasing faster from rent to food to gas prices. This has driven down real purchasing power. Here is what a Duke economics professor said:
“In real terms, the purchasing power of many families has actually gone down despite the fact they’ve received fairly significant wage increases. We have wage increases at a pace of 3, 3.5 percent which is really unusual for the past decade. A bout of high inflation that’s at 5 percent or 6 percent comes by and unravels that rather quickly.”
- Mortgage rates rising: At the same time inflation is rising, rates will have to rise substantially to control the increasing price pressures. Powell alluded to this today and this trend will only continue to accelerate. As rates rise, houses that are already expensive will be even more expensive in relative terms as payments also substantially increase.
- Consumer Sentiment: “Consumers expressed less optimism in the November 2021 survey than any other time in the past decade about prospects for their own finances as well as for the overall economy,” Richard Curtin, chief economist for the UMich survey said in the report. “The decline was due to a combination of rapidly escalating inflation combined with the absence of federal policies that would effectively redress the inflationary damage to household budgets.”
We have three negatives pulling on real estate at the same time while on the positive side inflation is creating a hunt for “hard assets” that will hold up in an inflationary environment. Furthermore, inventory remains at historic lows.
With this tug of war, I see two prospective scenarios:
- Flattening of prices: As rates rise and consumer sentiment drops, the pace of real estate appreciation will dramatically slow in 2022 with most markets flat to minor increases
- Minor correction: There is a 20-40% probability that inflation increases even more which will force the federal reserve to tighten even further which will put the brakes on the economy.
The Dow industrial average dropped 600 points after Powell’s speech on tightening at the federal reserve. At the same time treasury yields and in turn interest rates increased. These two factors along with consumer sentiment will have a profound effect on real estate in 2022.
As a result, there are two scenarios that could play out in 20222. The most likely is a flattening of real estate with prices up slightly to basically flat. The downside risk is that the federal reserve is forced to act more aggressively to control inflation which would lead to a much larger jump in interest rates and in turn a big slowdown in the economy. Although this is not the most likely scenario at this stage, the omicron variant and other factors could increase the probability and it is worth watching.
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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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