All eyes are on outgoing Federal Reserve Chairwoman Janet Yellen as the Federal Open Market Committee meets this week. It’s the final meeting of the year, and Yellen’s press conference on Wednesday will likely be her last.
Most analysts predict the FOMC will raise its benchmark interest rate by one quarter of a percentage point on Wednesday.
However, markets could react to Yellen’s commentary on future Fed actions, specifically future rate increases and Republican tax reform, says Michael Fratantoni, chief economist with the Mortgage Bankers Association.
The Fed is weighing the likelihood that tax reform will pass and spur positive economic growth. In turn, the Fed might consider a fourth rate hike in 2018, Fratantoni says.
Upward pressure on longer-term rates (such as 30-year fixed mortgage rates) is possible if Yellen’s remarks hint that the Fed is considering more frequent rate hikes in the years ahead, Fratantoni adds.
How the Fed’s actions could impact housing
What does all of this mean for mortgage rates and the housing market in general? Mortgage rates likely won’t see a wild swing, but the pace of growth in mortgage originations and home purchases might be hindered, Fratantoni says.
Some analysts are also wondering if Yellen will make any comments about Republicans’ proposed tax reform bills.
The Senate and House are reconciling their respective versions of tax reform legislation. Housing industry advocates worry that some housing tax revisions could dull the shine of homeownership.
For instance, the House version of the tax reform bill lowers the mortgage interest deduction cap to $500,000 for first homes only. The Senate version keeps the current cap in place at about $1 million, which homeowners can use on secondary homes, too.
Also, House Republicans want to increase the timeframe homeowners must live in their homes to claim the capital gains tax exemption on their primary residence.
Currently, homeowners are exempt from paying capital gains taxes on the first $250,000 ($500,000 for married couples) if they’ve lived in a home for at least two of the last five years. Republicans want to increase the timeframe to five of the last eight years.
If these changes take effect, homeowners might be less likely to move up into higher-cost homes and opt to stay put in their current homes much longer. Homebuyers in more expensive housing markets will feel the strongest headwinds, Fratantoni says.
Housing affordability continues to be a problem
It’s no secret that home prices are outpacing income growth. Consequently, it’s harder for consumers, particularly first-time buyers, to purchase a home.
A combination of higher mortgage rates (a result of gradually tightening monetary policy) and higher home prices will add to home affordability woes, says Robert Dietz, chief economist with the National Association of Home Builders.
The latter issue, he points out, is due to a lack of new construction and low resale inventory.
Any tax reform that weakens federal housing tax incentives will increase the costs of buying a home, Dietz says.
“On the other hand, tax reform has the possibility of increasing wage growth and sustaining ongoing increases in employment. Both are broadly positive factors for rental and for-sale housing demand,” Dietz says.
More entry-level housing — new construction and resales — is desperately needed to keep pace with buyer demand.
Fed keeping an eye on low inflation
Economists are interested in seeing if the Fed says anything about inflation. U.S. inflation has run below the Fed’s 2 percent target for some time, suggesting more long-term issues at play that could lead to deflation, Yellen recently testified before Congress.
Why is this important? A certain amount of inflation is beneficial for people who borrow money today or in the near future, Fratantoni says. It’s better to pay down loans borrowed with dollars that have lost value due to inflation while prices of goods remain stable. If the rate of inflation becomes too high, mortgage rates will rise, too.
The opposite happens in deflation, however, when the prices of goods and services decrease following an economic crisis, according to the Brookings Institution, a nonprofit public policy organization.
When deflation becomes sustained, as it was during the Great Depression, the value of the dollar goes up. As a result, consumers and investors spend less and hoard their money. A snowball effect occurs: consumer demand falls and corporate profits contract. Companies then slow the pace of hiring and cut wages to stay profitable.
In her testimony, Yellen indicated the economy will likely reach the Fed’s 2 percent target range for inflation. However, it’s an issue she said the Fed is keeping close tabs on.