Intervention(s)
Background: The effectiveness of monetary policy largely depends on the extent to which it influences agents' expectations. Financial markets and investors typically pay close attention to Central Bank announcements. However, prior research indicates that households tend not to incorporate changes in monetary policy into their decisions (Lamla and Vongradov, 2019; Journal of Monetary Economics). This oversight diminishes the effect of new monetary policy strategies and creates inefficiencies in markets.
Fed’s Expected Policy Change: Over the past two years, the Fed has effectively utilized the base policy rate to control inflation. This "hawkish" approach resulted in interest rates rising from the 0.25%-0.50% range to a 5.25%-5.50% interval. Nonetheless, monetary tightening comes at a cost. High interest rates suppress consumer spending and decelerate the economy, posing a potential risk of recession. They also increase the treasury's debt service burden. Financial forecasters anticipate that maintaining excessively high base rates could lead to a "hard landing," i.e., a recession. Conversely, financial analysts believe that the Fed should begin lowering rates this year to ensure a "soft landing." Some also speculate that the election year might pressure the Fed to initiate quantitative easing (QE).
The hawkish monetary policy has significantly impacted the housing market as well. The average mortgage rate reached about 8% in October 2023, creating a challenging environment for both buyers and sellers and particularly limiting the supply of inventory. Homeowners are postponing the listing of their properties due to the limited demand. Analysts predict that the housing market will recover, and homeowners will be more inclined to list their properties once the Fed begins to lower the rates.
Six or three cuts? In the last early-January meeting, the Fed signaled that it would consider rate cuts. However, contrary to the market expectations, the Fed’s announcement hinted at three cuts (i.e., around 75 or 100 bps reduction). Analysts believe that the Fed will eventually “capitulate” and implement six cuts (i.e., about 125 or 150 bps reduction). Some think that six cuts will turbo-charge the economy and will help the incumbent in the presidential elections. The Fed’s March 20 meeting will determine which monetary policy scenario is in play. A policy rate cut in March will be indicative of a 125 or 150 bps reduction in base rate by the end of 2024. As of January 17th, the market predicts with ~56% probability that the Fed will cut the rate in March.
The Effect of QE on Housing Markets: Anticipated reductions in the policy rate are likely to decrease mortgage rates, stimulating demand for housing inventory. Nonetheless, the resultant change in price dynamics will hinge on the speed at which supply responds. With companies increasingly reverting to in-person work, employees working in hybrid or remote modes are being required to return to major metropolitan areas. This shift to in-person work could bolster inventory in the housing market. However, as mortgage rates fall, previously priced-out buyers may re-enter the market, potentially leading to robust demand. Consequently, net housing prices may rise or fall across different regional markets, contingent upon the supply-demand equilibrium.
Research Questions:
1. To what extent are homeowners aware of and responsive to the Fed's monetary policy announcements? Do potential rate cuts by the Fed influence homeowners' market expectations?
2. The economic news landscape presents both positive (home prices will increase) and negative (home prices will decrease) scenarios for homeowners. How does the tone of an economic news piece influence their willingness to list properties?
3. What is the "diffusion rate" of the Fed's policy announcements? Will homeowners adjust to base rate reductions as the market anticipates?