The Federal Reserve recently announced a cut to the federal funds rate for the first time since the Great Recession (view their statement). The move is intended to make borrowing easier as a way to inject new energy into the economy. The good news for prospective homebuyers in the near future is that mortgage rates are expected to ease, reducing the cost of borrowing. This should make it easier to qualify, help a customer afford a more expensive home, and/or reduce the overall cost of homeownership. All of those things are a plus in a housing market that is experiencing a shrinking affordability puzzle for the average consumer, as detailed in one of my previous pieces for the Star Report (check it out). While those benefits are real and a positive impact on the industry (which needs it) in the short run, the reduction of the funds’ rate signals growing concern with the overall economy.
The FED has been slowly raising rates over the last few years. However, rates continue to be very low historically even as the moderate increases have taken place from the near-zero level at the heart of the Great Recession. The FED’s two primary mandates are to maximize employment and maintain steady inflation (around 2%). If inflation grows beyond wages, the spending power of the average consumer decreases, which reduces consumer spending and can trigger a recession. Typically, the concern over inflation drives the FED to raise rates proportionately as the economy expands while near full employment.
However, the inflation expected hasn’t really occurred. This is especially odd given the fact that unemployment is below 4%. Typically, we expect that level to signal we’re at full employment, which should lead to more competition for labor and drive up wages, spending, and thus prices as a result (as demand rises, so do prices). This isn’t occurring, which suggests that we may not be at full employment after all— something others have argued given lower-than-ideal labor participation rates.
Economic theory teaches that you don’t loosen the supply of money when you have an expanding economy; instead, you do so when you have a contracting economy. Keep in mind that contraction doesn’t equal a recession. A contraction could simply mean a slower growth rate. Regardless, the rate cut should be read as a sign of concern. Manufacturing numbers have declined, as has the pace of job growth. China’s growth has been slowing, the trade war doesn’t seem to be ending any time soon, and global tensions are rising.
Most economists have been forecasting a pullback in the near term for a while largely based on the length of the current expansion and the historical record on these cycles. The real risk we face isn't a basic recession. The real risk is that by lowering the rate now to extend the expansionary cycle, the FED is weakening the only tool it has to combat a recession when it hits.
With a deficit that is expected to exceed a trillion dollars, a strategy that is also counter to an economic theory where you traditionally aim for surpluses during growth years to run deficits during downturns, and the fact that the American government will be without the two most potent tools it used to pull the country out of the Great Recession (deficit spending and lowering interest rates), there is quite a combination when it comes to what's happening.
Ultimately, this rate cut is probably a short-term boost to the housing market and the economy writ large. However, we may be a single economic shock away from a major problem. The Great Recession was so painful because there was systemic contagion. While the systemic contagion risks may not be the same, that doesn't mean we don't have similar risks. If that happens, we may not have any tools in the tool belt to fight it off.
