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In an effort to combat inflation, the Federal Reserve made its steepest rate hike in 22 years (half a percentage point) and announced a plan to throw the money printing machine in reverse next month.

The Fed hiked the federal funds rate by half a percentage point and will sell $47.5 billion per month in bonds and mortgage backed securities from June to August before increasing the pace in September.

The Fed added about $4.6 trillion in bonds to its balance sheet over two years in response to the COVID-19 pandemic.

For homebuyers, the Fed’s hawkish stance puts upward pressure on mortgage rates. However, since the half point rate hike was long foreshadowed and widely expected, much of that pressure may already be baked into the market.

In fact, mortgage rates actually fell following the announcement, suggesting the expected rate hike provided stability in the market.

But all Fed announcements are a mixed bag, so here is the good, the bad, and the ugly from today’s policy moves.

via GIPHY

What's in this Article?

The Good
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The Bad
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The Ugly
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The Good

As mentioned, the half point rate hike was expected and unanimously voted upon by the Federal Open Markets Committee (FOMC). Fed Chair Jerome Powell also made a point to say that although more rate hikes can be expected, the FOMC is not even considering a higher increase at future meetings.

This stability should keep markets relatively calm and mortgage rates in the 5’s. Here’s why that’s a good thing.

The second positive takeaway is that Powell said there is a “good chance to have a soft or softish landing.” A soft landing refers to inflation coming back down to the target range of 2% without a crash or recession.

Powell also said in a press conference that the Fed’s “monetary policy is working to expectations now” and there’s evidence that inflation may have peaked.

Now, everything the Fed says should be taken with a grain of salt because it goes out of its way not to spook the market. However, it’s encouraging that there were no surprises in today’s announcement and as a result the Dow Jones Industrial Average increased 900 points. (See the next section for an update on Thursday's market reaction)

The bottom line for homebuyers is that today’s Fed moves lay the groundwork for slower price growth in the coming months and years.

The Bad

Update: Following a 900 point gain on Wednesday, the DOW lost 1,063 points on Thursday for its worst day since 2020, suggesting the rate hike, although expected, wasn't baked into the market.

For homebuyers, hawkish Fed policy is a double-edged sword. Hiking rates and shrinking the balance sheet should cool price growth over time, but it comes at the expense of higher mortgage rates.

Record low rates during the pandemic created homebuying opportunities for a wider swath of people, which fueled demand and led to price growth. Now, we’re seeing the opposite. Rising rates and home prices are eroding affordability and sidelining low-income and first-time homebuyers.

So the Fed policy should cool price growth over time, but at the expense of pricing out lower income homebuying groups.

And we are way past the point of no return for mortgage rates in the 3’s and 4’s. The Fed plans to continue making half-point rate hikes with the goal of a federal funds rate of 2.5% or higher by the end of the year.

For those not keeping track of the federal funds rate, it was between 0% and 0.25% from March 2020 to March 2022 and is currently between 0.75% and 1%. This rate does not directly impact mortgage rates, but it does steer market activity to create higher rates and reduce demand.

Inflation peaking is also a double-edged sword. First of all, peak inflation is not a happy place to be in the short term – even if sunnier days are ahead. And with inflation currently at 8.5% and a “good chance” at a soft landing, that means we’re likely in for several more months of high cost of living.

The Ugly

The Fed let slip a few ugly truths in today’s announcements.

First, inflation is a moving target fueled by several volatile sources and, as such, is proving to be a tough, shape-shifting beast to tame.

Here’s the FOMC’s take on inflation from today’s statement:

“The invasion of Ukraine by Russia is causing tremendous human and economic hardship. The implications for the U.S. economy are highly uncertain. The invasion and related events are creating additional upward pressure on inflation and are likely to weigh on economic activity. In addition, COVID-related lockdowns in China are likely to exacerbate supply chain disruptions. The Committee is highly attentive to inflation risks.”

Translation: We’re not out of the woods yet and the trail keeps splitting.

In the post-meeting press conference, Powell basically admitted that all the Fed has is hammers, but not everything is a nail.

“We don’t have precision surgical tools,” Powell said. “We have essentially interest rates, the balance sheet and forward guidance and they’re ... famously blunt tools.”

So the Fed is using its tools to combat inflation and doing so in a way that won’t shock the market. However, the Central Bank is limited to playing whack-a-mole even though the game is 3D chess.

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