June — The Real Federal Funds Rate

This year has been full of mortgage rate talk, Fed rate talk and a lot of doom and gloom from the media. 

Let’s take a minute and talk about The Neutral Interest Rate or the Real Federal Funds rate! This is calculated by taking the nominal Fed Funds Rate and subtracting inflation. (Fed Funds Rate – Inflation = The Real Federal Funds Rate)

With the Fed Funds Rate currently sitting at 0.75%, and if we use the PCE Inflation data, which is 5.2%, the Real Fed Funds Rate is -4.45%. 

Does that mean the Fed will need to raise rates by this amount to reach neutral? Not necessarily, because by raising the Fed Funds Rate, this destroys demand, which in turn lowers inflation. With lower inflation, this changes the amount being subtracted off the Fed Funds Rate, which in turn changes how much they need to increase it to reach Neutral Interest Rates. 

The Fed’s main goal was to lower inflation this year since 7% or 8% inflation is just out of control. While the Fed hasn’t said this, I think one of their other goals is to reach a Neutral Interest Rate, which is a little bit of a moving target, but can give us some insight as to when they will stop raising rates. 

I still believe that around Q4 is when the Fed will reach a point where they feel good about inflation data, and we can start to see some improvement on the mortgage rate front. 

Housing is beginning to slow based on the most recent data which showed new home sales were down 17% in April and year-over-year down 27%. This, of course, is based on “new” home sales, which means from builders and new construction properties, but that makes sense. With the cost of building increasing and supply chain delays, builders have not been able to produce the number of homes they were able to produce in years past. 

If we take out the data-only analysis and use the boots-on-the-ground approach, we’re starting to see more inventory hit the market. Our real estate agents are still seeing multiple offers on homes and homes going for over the list price. 

However, the overall sense is that it’s not as crazy as it was in 2021 and the trend is moving towards a more normalized market. 

While I’m not suggesting that we see home prices go down significantly, I do think we’re starting to see a shift from sellers having an extreme upper hand to a more normalized market where values are strong, but buyers and sellers will need to find common ground. 

I believe it’s still a great time to buy as real estate has and always will be a long-term investment. Even with rates going up, the home is permanent and the rate you get at closing can be temporary if rates ever go down. 

A great example is a client of ours who bought a home in 2010 in Redondo Beach for $775,000 with a rate of 5.25%. Over time, rate markets changed, they refinanced a couple of times to lower their payment, and now 12 years later, I think we can all agree that it was a great decision given the home’s current value. 

Sign up to get “My Two Cents.” It’s a blog where I share my thoughts on everything related to real estate finance.