|Fed chairman Jerome Powell considered the reduced rates a “mid-cycle adjustment to policy” / Photo by WANGKUN JIA via 123rf|
The Federal Reserve System, the central banking system of the United States, cut its main interest rate in August by 25 basis points, and it was their first reduction since the financial crisis. Investment and finance education platform Investopedia explained that the Fed lowered interest rates to stimulate economic growth because lower financing costs encourage investing and borrowing. In a press conference, Fed chairman Jerome Powell considered the reduced rates a “mid-cycle adjustment to policy.”
Housing market: biggest contributor to the US economy
One particular place where the Fed is playing out its mid-cycle adjustment is in the US housing market. This is according to a former adviser to the president of the Dallas Fed Danielle DiMartino-Booth. She said that the housing market is now at 15 percent and is the single-largest contributor to the economy and will continue to support its growth.
Since housing is an interest-rate sensitive industry, it will benefit more than other sectors from the Federal Reserve’s plan of cutting its interest rate by half a percentage point. Not to mention that mortgage rates in the US have also declined more than one percentage point for the past year expecting of the Federal Reserve’s easing, which means a relief to the residential real estate industry.
|Fed is playing out its mid-cycle adjustment in the US housing market / Photo by Andrea De Martin via 123rf|
US mortgage rates
Bloomberg likewise detailed low mortgage rates in the United States. This means that purchasing a home in the country becomes more affordable. In 2001, the US had a 7.2 percent mortgage rate that fell to 5.7 percent in 2005. In 2010, the mortgage rate went down to 5.0 percent and then to 3.7 percent in 2015. As of August 2019, the US mortgage rate was at 3.6 percent.
The mortgage rate is the main consideration for potential homebuyers if they are planning to purchase through a mortgage loan. Other factors they also consider are insurance, taxes, interest, and principal.
Based on the Index of Traffic of Prospective Buyers of the National Association of Home Builders (NAHB), which is a trade association in the US that produces economic analysis of the home building industry in the country, there was a positive traffic of potential homebuyers in the months of August and September compared to a decline in the last 12 months.
Last August, the housing industry likewise hit 1.36 million on an annualized basis. DiMartino-Booth, who is also the founder of economic consulting firm Money Strong LLC, said that the start of gains in the housing market was contributed by the multifamily properties. Today, single-family housing is encouraged and is viewed favorably to be an important “driver of economic growth.” It even reached its seventh-month high. As more houses start rising, so does the potential buyers.
Millions of building permits
The building permits have also reached millions in the US, continued Bloomberg. From 1,044,000 in 2013, it increased to 1,367,000 in 2015, 1,245,000 in 2017, and 1,425,000 as of August 31, 2019.
Effect of the housing market in the economy
Increased house prices encourage consumer spending and it also means higher economic growth. A drop in house prices, on the other hand, affects construction and consumer confidence, leading to low economic growth. Increased house prices redistribute wealth in the economy. The wealth effect is explained in these three things:
1. Increased confidence - people are more willing to spend money.
2. Equity withdrawal - a rise in house prices enables the homeowner to take a bigger mortgage and they can use the loan also on other items, leading to increased consumer spending.
3. Increased income - this covers dividends, rent, and interest.
Nominal housing prices indicator
The Organization for Economic Cooperation and Development (OECD), an international group that shapes policies to foster opportunity, well-being, equality, and prosperity for all, previously detailed the housing prices of different countries. It said that the main elements of housing costs are: (1) price to income, (2) ratios of price to rent, (3) nominal and real house prices, and (4) rent prices.
To highlight the nominal housing prices, it covered the sale of the existing dwellings and newly built properties. America’s nominal housing price in 2015 was 100, while it was and 120 in 2018. The rent price in the US in 2015 was 100, 111.6 in 2018. An increase in house prices also creates a positive wealth effect and impact on the economic growth of the US.
Another country the OECD highlighted was Iceland with its nominal housing price of 100 in 2015 and 142.0 in 2018. Meanwhile, Iceland’s rent price was 100 in 2015 and 113.9 in 2018. The second country with a high nominal price next to Iceland was Turkey. Its nominal house price was 100 in 2015 and 134.9 in 2018. The third was the People’s Republic of China with a 134.3 nominal house price in 2018. It was followed by Hungary with a 131.7 nominal house price in the same year.
The country with the lowest nominal house price in 2018 was Russia at 93.5. The second-lowest was Greece at 98.1.