“Bubble Watch” digs into trends that may indicate economic and/or housing market troubles ahead.
Buzz: The last time “core” inflation — an odd price benchmark that’s carefully tracked by the Federal Reserve — was as high as it is today, mortgage rates were nearly 10%.
Source: My trusty spreadsheet looked at the historic ties between mortgages (Freddie Mac’s 30-year average rate) and the “sticky inflation” measurement by the Atlanta Fed. This cost-of-living yardstick excludes volatile inflation factors such as food and energy and instead focuses on slow-to-change spending categories. (Yes, this concept of “core” inflation seems insulting to anybody who tries to meet a household budget, but it’s a Fed favorite so it must be watched.)
The pandemic era’s economic bailout by the Fed is over.
This was the message sent Wednesday when the central bank raised its benchmark rate by three-quarters of a percentage point, its largest hike since 1994.
The previous cheap money policies, designed to help the economy escape a coronavirus chill, kept rates too low for too long. Those stimulus tactics overheated demand and prices of numerous goods and services — notably housing.
The last time sticky inflation was above 5% it was May 1991 and mortgage rates ran 9.47%. Borrowers were paying a 4.22 percentage-point “premium” above a 5.25% annualized gain in sticky inflation.
In May 2022, that cost-of-living metric was surging by 4.98%, yet the month averaged 5.23% mortgage rates. That’s only a 0.25-point premium.
It sounds like today’s borrowers may still be getting a relative bargain, even after this year’s jump in rates.
The nation was in an economic funk in the spring of 1991 when “core” inflation was last this hot.
Iraq’s invasion of Kuwait in the summer of 1990 pushed oil prices skyward. Those costs helped nudge the U.S. economy into a brief and mild recession that ended in March 1991 — just as the first Gulf War that liberated Kuwait ended swiftly.
May 1991’s U.S. unemployment rate was 6.9% — up from vs. 5.4% a year earlier — and nationwide spending, after inflation, was falling at a 0.4% annual pace. Meanwhile, nationwide home prices had fallen 1% in a year.
Contrast that snapshot to this spring, where the economy’s story is “too much good stuff” — joblessness is down to 3.6% from 5.8%, and spending is running 8.5% higher, after inflation. Not to mention, home prices are 19% above the previous year.
Remember, inflation is a key part of the rate-setting process. Lenders want to make sure that they get paid back with dollars worth more than the money borrowed. And one of the Fed’s main chores is keeping the cost of living in check with interest rates as the central bank’s main economy-tweaking tool.
But what’s a “proper” premium between inflation and mortgages? Let’s ponder history.
1971-87: An era of high inflation was ended by the tough love of Fed Chairman Paul Volcker’s sky-high rates. A lengthy economic boom came next. Sticky inflation ran 4.6% throughout this period vs. 9.6% mortgages — a steep 4.7 rate-to-inflation premium. Unemployment was at 6.6%, homes had 5% annual gains.
1987-2005: Fed Chairman Alan Greenspan’s cheap money policies surprisingly didn’t overheat the cost of living — 2.3% sticky inflation during this reign vs. mortgages at 5.9%, a 3.6 rate-to-inflation premium. Unemployment fell to 5.5% and homes saw 5.4% annual gains. As Greenspan departed in 2006, though, the real estate bubble was brewing.
2006-2019: A bursting bubble created a global economic meltdown followed by a long-running rebound. Again, there were few cost-of-living pressures with 2.5% sticky inflation and mortgages that dipped to 4%, translating to a thin 1.5-point rate-to-inflation premium. Unemployment — which soared in the Great Recession — was at a 4.1% pace for the entire period. And home prices, which plummeted initially, ended up with 5.9% annual gains.
2020-21: The pandemic upended the economy — and cheap-money efforts to minimize business fallout created a 3% mortgage rate era vs. 2.3% sticky inflation, a narrow 0.7 premium. Unemployment ran 6.7% while low rates helped create oversized 12.3% annual home-price gains.
So, will borrowers still enjoy mortgage rates not much above inflation as the Fed’s current battle to cool a surging cost-of-living intensifies?
Ponder how cheap mortgages were in the pandemic era.
Between November 2021 and March, slowly rekindling sticky inflation ran above average mortgage rates — yes, loans were at a discount, not a premium.
It was only the third time this oddity happened in a half-century. The others were 13 months in 1974-75 (9.3% mortgages vs. 11% inflation) and six months in 1980 (12.8% mortgages vs. 13.9% inflation).
On a scale of zero bubbles (no bubble here) to five bubbles (five-alarm warning) … THREE BUBBLES!
The Fed’s rate hikes could return sanity to homebuying. But how expensive could mortgages get?
Looking at an economic track record that spans the past half-century, you see the typical mortgage rate has been 4.3 percentage points above sticky inflation — 7.4% on the loans vs. 3.1% on this “core” cost-of-living yardstick.
And if you add that historic premium to May’s 4.97% sticky inflation — that’s mortgages nearing 10%!
Jonathan Lansner is the business columnist for the Southern California News Group. He can be reached at [email protected]