The Federal Reserve has raised short-term interest rates to banks another quarter point -- as it has for 17 straight meetings since June 2004. The lag effect on long term interest rates, such as mortgages, is they also rise.
At least that's how it's supposed to work. It should cost more to borrow long-term money than short-term money costs banks. Lenders can only make money when they loan at higher rates than they pay.
While the rate hike was widely expected, this last rise brings real estate close to a key psychological and monetary test. According to Freddie Mac, the 30-year fixed-rate mortgage is now averaging 6.78 percent, which is the highest it's been since May 24, 2002, when it averaged 6.82 percent.
"Financial markets continue to expect more rate hikes by the Fed over the next six months, which has added upward pressure on mortgage rates," said Frank Nothaft, Freddie Mac vice president and chief economist. "With higher interest rate, the housing market has begun a gradual and orderly reversion towards historical norms."
The Fed's position is that "some inflation risks remain" even though there is other evidence, such as the rapidly cooling housing market and other signs of slowing economic growth, that inflation risks could be contained.
Housing which is judged by rising or falling inventories and prices, has been showing signs of slowing both in sales and prices.
The National Association of Realtors reported sliding sales 6.6 percent lower in May 2006 than in May 2005 and home prices are 6 percent higher than last year's, but that illustrates a slowing rate of appreciation from an annualized rate of over 12 percent for 2005.
Rising inventories nationwide average 6.5 months of inventory on hand, which is the tipping point for a buyer's market. Buyer's markets are characterized by rising inventories, longer days on market, price reductions, and seller concessions.
In May, David Lereah, chief economist for the NAR sounded his warning that the Fed should not raise rates much further or risk throwing the economy into recession. While rising interest rates could harm some markets, job growth in other markets is keeping housing balanced for the time being.
"Seven percent is not a key point," says Lereah. "The announcement today made it clear that the Fed is very concerned about the housing sector and the economy. The Fed took the Fed funds rate to 5.25 percent. I believe they will take it to 5.5 percent and stop. If they stop -- we will be okay. If they continue towards 6 percent -- mortgage rates will approach 7.5 percent, which is the tipping point for our interest sensitive markets."
