The Fed Has a Real Estate Fight on Its Hands

A fight is brewing at the Federal Reserve about housing prices, and there’s no easy way to resolve it without either spurring record home costs to rise even more or disrupting increasingly complacent asset markets.

Both options are bad for a central bank that has a history of withdrawing accommodation prematurely. The Fed’s hand will be tipped if members determine that high property values are starting to substantially threaten financial stability, which is the subject of a discussion between Fed Chair Jerome Powell and Treasury Secretary Janet Yellen on Friday.

The angst over home prices was spotlighted on Wednesday during Powell’s testimony to the House Financial Services Committee. He conceded that last year’s 15% increase in housing prices was “too much,” but he blamed a lack of available homes more than low rates and record amounts of mortgage debt. Besides, Powell argued, there would still be plenty of demand for homes even if mortgage rates rose.

That said, there’s growing disagreement on the Fed. St. Louis Fed President James Bullard and Fed Governor Christopher Waller, among others, have argued for an earlier end to the central bank’s $40 billion of monthly mortgage-debt purchases, which have been taking place since the Covid-19 pandemic began. But the Fed’s top leadership, namely New York Fed President John Williams and Powell, have pushed back, indicating that pulling away from this market may hurt more than it would help.

Their argument has some validity. If the Fed starts tapering sooner, that will indicate tighter monetary policy ahead, with faster interest-rate increases and potential cuts to monthly Treasury purchases. That would shock a market that has become complacent in thinking the Fed will remain on hold for the foreseeable future.

Perhaps that wouldn’t be so bad. It’s not just housing prices that seem uncomfortably high. The S&P 500 Index just set seven consecutive records in the period ended July 2, the longest streak of all-time highs since 1997. Riskier companies are selling a record amount of bonds with all-time low yields.

But the Fed can’t fine-tune the market’s response, and a slight hawkish tilt after its last meeting led to a flattening yield curve, or lower long-term growth expectations. The bond market seemed to be signaling that it’s still too soon to tighten policy. This is precisely what the central bank does not want to see.

Still, Powell was a little disingenuous when he pointed more to supply side issues — a lack of housing in the areas where people wanted to most buy — as the main driver of high valuations. He seemed to indicate the central bank didn’t have that much influence on the property market. It’s hard to buy this argument when U.S. housing debt surged to an all-time high of $10.5 trillion as of the end of March and banks can’t staff their property-loan units quickly enough. This is clearly at least partially a byproduct of mortgage rates being so low.

The Fed’s internecine fight over housing is becoming increasingly public, and rightly so. The central bank’s policies are clearly helping to inflate home values and the market for mortgage debt. Some Fed members may think it’s worth it to give the economy time to accelerate. It’s a trade-off, and not an easy one to make, with serious consequences for either decision.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Lisa Abramowicz is a co-host of "Bloomberg Surveillance" on Bloomberg TV.

©2021 Bloomberg L.P.

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