“Bubble Watch” explores trends that may indicate upcoming economic and/or real estate market problems.
Buzz: The last time “core” inflation – an odd price benchmark that is carefully tracked by the Federal Reserve – was as high as it is today, mortgage rates were close to 10%.
Source: My trusty spreadsheet examined the historical links between mortgage lending (Freddie Mac’s 30-year average rate) and the Atlanta Fed’s measure of “persistent inflation.” This cost-of-living measure excludes volatile inflationary factors such as food and energy and instead focuses on slow-to-change expense categories. (Yes, that concept of “core” inflation sounds insulting to anyone trying to stick to a household budget, but it’s a Fed favorite, so watch it.)
The Fed’s pandemic-era economic bailout is over.
That was the message sent on Wednesday when the central bank raised its key rate by three-quarters of a percentage point, its biggest hike since 1994.
Previous cheap money policies, designed to help the economy escape the coronavirus chill, have kept rates too low for too long. These stimulus tactics have overheated demand and prices for many goods and services, including housing.
The last time inflation was above 5% was in May 1991 and mortgage rates were 9.47%. Borrowers were paying a “premium” of 4.22 percentage points above a 5.25% annualized gain in persistent inflation.
In May 2022, this cost-of-living measure rose 4.98%, but the month averaged mortgage rates of 5.23%. It’s only a 0.25 point bonus.
It looks like today’s borrowers can still get a bargain even after this year’s rate hike.
The nation was in an economic crisis in the spring of 1991, when “core” inflation was last so high.
Iraq’s invasion of Kuwait in the summer of 1990 caused oil prices to skyrocket. These costs helped push the US economy into a brief, mild recession that ended in March 1991 – just as the first Gulf War that liberated Kuwait quickly ended.
The unemployment rate in the United States in May 1991 was 6.9% – down from 5.4% a year earlier – and national spending, after inflation, was declining at an annual rate of 0.4%. Meanwhile, home prices nationwide had fallen 1% in one year.
Compare this snapshot to this spring, when the economy story is ‘too many good things’ – unemployment is down 5.8% to 3.6% and spending is up 8.5%, after inflation . Not to mention that house prices are 19% higher than the previous year.
Remember that inflation is a key part of the rate setting process. Lenders want to ensure that they will be repaid with dollars worth more than the money borrowed. And one of the Fed’s main tasks is to keep the cost of living in check with interest rates as the central bank’s main economic adjustment tool.
But what is a “good” premium between inflation and mortgages? Let’s think about history.
1971-87: An era of high inflation ended with Fed Chairman Paul Volcker’s tough love of sky-high rates. A long economic boom followed. Sticky inflation was 4.6% throughout this period versus 9.6% for mortgages, a hefty 4.7 rate premium to inflation. Unemployment was at 6.6%, houses had annual gains of 5%.
1987-2005: Fed Chairman Alan Greenspan’s cheap money policies have surprisingly not overheated the cost of living – 2.3% persistent inflation during his reign against mortgages at 5.9%, a 3.6 rate premium to inflation. Unemployment fell to 5.5% and homes posted annual gains of 5.4%. However, when Greenspan left in 2006, the real estate bubble was brewing.
2006-2019: The bursting of a bubble created a global economic collapse followed by a long lasting rebound. Again, there was little pressure on the cost of living with inflation persisting at 2.5% and mortgages falling to 4%, resulting in a low rate/inflation premium by 1.5 points. Unemployment – which soared during the Great Recession – was at a rate of 4.1% for the entire period. And house prices, which had initially fallen, ended up with annual gains of 5.9%.
2020-21: The pandemic has upended the economy – and cheap money’s efforts to minimize the trade fallout have created an era of 3% mortgage rates against persistent inflation of 2.3%, a narrow premium of 0.7. Unemployment stood at 6.7%, while low rates helped create outsized annual gains of 12.3% in house prices.
So will borrowers still benefit from mortgage rates slightly above inflation as the Fed’s current battle to quell the soaring cost of living intensifies?
Think about how cheap mortgages were in the pandemic era.
Between November 2021 and March, sticky inflation that slowly revived exceeded average mortgage rates – yes, the loans were at a discount, not a premium.
It was only the third time this oddity had happened in half a century. The others were 13 months in 1974-75 (9.3% mortgages against 11% inflation) and six months in 1980 (12.8% mortgages against 13.9% inflation).
On a scale of zero bubble (no bubble here) to five bubble (five alarm warning)… THREE BUBBLES!
The Fed’s rate hikes could give new meaning to buying a home. But how expensive can mortgages be?
Looking at an economic record spanning the last half-century, you see the typical mortgage rate has been 4.3 percentage points above sticky inflation – 7.4% on loans versus 3 .1% on this “basic” cost of living criterion.
And if you add this historic premium to May’s persistent inflation of 4.97%, mortgages are approaching 10%!
Jonathan Lansner is the business columnist for the Southern California News Group. He can be contacted at firstname.lastname@example.org
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Post expires at 10:21pm on Wednesday June 29th, 2022