Rising US mortgage interest rates undercutting housing market recovery, which would otherwise continue to 'serve as source of strength' for economic recovery, says president of Federal Reserve Bank of New York

September 30, 2013 () – Rising mortgage interest rates are undercutting a revival in the housing market and creating a drag on the economy, said the president of the Federal Reserve Bank of New York.

At a time when the still-struggling economy could use the continued source of consumer spending that the housing sector has provided, that support is likely to be blunted, said William Dudley, speaking at Fordham University in New York on Sept. 23.

Noting that excess supply of housing is way down, while home prices and homebuilding are up, Dudley said that were it not for the dampening effect of rising rates, "the housing market could serve as a source of strength, as it has been doing."

The fundamentals of the industry are good, Dudley said, with "further scope for gains in homebuilding." Current housing starts of about 900,000 annually are, he said, "considerably below the rate consistent with the country's underlying demographic trends and the expected long-run rate of household formation." He added that, "housing starts should ultimately climb back to about a 1.5 million annualized rate."

Lined up against these factors, though, are rising interest rates. "The increase in financing costs and the rise in home prices has made housing considerably less affordable than it was earlier in the year," said Dudley.

"Data through mid-September generally indicate that the rise in rates has cut into the upward momentum of the housing sector," he said.

Consumers are, in general, loath to spend, he said. "In July, for example, real personal consumption expenditures were flat, and it is unlikely that third quarter consumption growth will be much above a 2% annual rate." Dudley linked this lack of enthusiasm for spending to the weak employment market, where "disposable income growth is below 2%."

The economy, Dudley said, is caught in a bind: "Stronger consumption growth will require a pickup in income growth. But for income to rise, demand must increase."

Hanging over this, and tied to the Federal Reserve Board's monetary policy, is the widespread concern about the job market.

Dudley, who is vice chairman of the Federal Open Market Committee, the body within the Federal Reserve Board that sets monetary policy, explained the Fed's previous week's surprising decision to continue its bond purchases by saying there was still too little evidence of sustainable improvement in employment and growth in the economy.

"I was not willing to support a tapering," he said. The result is the Fed will continue monthly purchases of $45 billion in long-term Treasury securities and $40 billion of agency mortgage-backed securities.

Though the unemployment rate has declined to 7.3% from 8.1% since bond purchases began last September, "this decline overstates the degree of improvement" in the job market, because only those actively looking for work are counted, said Dudley.

and businesses will do with their money."

Speaking of the inflation rate, which has been drifting downward the past two years, hitting 1.5% last month, Dudley said, "my outlook is for inflation to drift back toward our 2% objective over the medium term. However, much like the case of the real growth outlook, there is significant uncertainty around this forecast."

As a general rule, he said, "we will push the economy along to help the labor market improve while we also keep an eye on inflation. It's a balance."

In a speech otherwise replete with cautions on the economic outlook, Dudley ended by saying: "As we move into 2014, the fiscal headwinds should abate somewhat. As that occurs, the improving underlying fundamentals of the economy should begin to dominate, pushing up the overall growth rate."

Dudley used the occasion to announce that the New York Fed will be testing a tool called a fixed-rate, full-allotment overnight reverse repo facility. Admitting that the "name is a mouthful," Dudley said the new tool would be "available to a broad range of counterparties, not just open to the primary dealers through which we have historically conducted our open market operations." Being more widely available, he said, "should allow the Fed to tighten its control over money market rates" and is "likely to reduce the volatility of short-term interest rates."
(c) 2008 Source Media Inc. All Rights Reserved.

* All content is copyrighted by Industry Intelligence, or the original respective author or source. You may not recirculate, redistrubte or publish the analysis and presentation included in the service without Industry Intelligence's prior written consent. Please review our terms of use.