For real estate investors, “transitory” may be the most important word of 2021. This is because the Federal Reserve describes the current bout of inflation in the United States as transitory. Inflation, or a broad rise in prices for goods and services, is currently at its highest levels in 10 to 20 years.

Inflation is running at its highest level in a very long time.

Inflation has increased significantly since the last time it was this high, and many people believe that we have new methods and ideas in place now that will protect us from any immediate dangers.

But inflation isn’t something we’ve solved yet. It’s still a relevant topic and it’s been around since money was first created. It could have a huge impact on the housing market in the near future.

There have been a lot of unprecedented things done in order to try and improve the economy, and it would be foolish to assume that anyone knows exactly what will happen as a result.

What you should know about today’s Federal Reserve Board

Jerome Powell, chair of the Federal Reserve Board, has mentioned the word “transitory” over 150 times in 2021 to describe current inflation.

They don’t debate that inflation exists, right now as you read this. What they’re trying to preach is—deep breath, the sermon gets intricate here:

  1. The worst of this inflation is here right now, and will only keep rising another month or two before quickly receding to a normalized level that will be low enough to keep interest rates in the 2% to 3% range on the 10-year Treasury. This would equate to keeping mortgage rates in the 3% to 3.5% range, where they’ve been hanging around lately.
  2. Assuming the economy remains solid, starting sometime in 2022 they can begin to gradually raise short-term rates over 2 to 3 years. That will in turn will push up the entire yield curve to a level close to “recent historical norms.” Translation: 4% to 5% rates on the 10-year, resulting in 5% to 6% 30-year mortgage rates.

In this scenario, housing markets would have time to slowly adjust to higher mortgage rates instead of crashing, while personal incomes and things like rents steadily increased.

Why is this Federal Reserve sermon important? Because the Open Market Committee is the group that sets short-term interest rates, which effectively dictate the trajectory of the entire yield and mortgage rate curve.

A look at the most recent inflation trends in addition to the historical context can give us a better understanding of the current situation. This is especially important for those with a mortgage, those looking to buy more property, or those whose investment portfolio relies on rental income.

The current picture

There are a few different ways that economists measure inflation to understand the current state. I know that this topic might seem really boring to a lot of people, but it’s actually really important.

The CPI is the most cited measure of inflation. It looks at a large basket of goods and services that people spend money on each month and notes how much every item went up or down in price from the month before. It’s not perfect, but it’s the best we have.

Most concerning about the inflation we’re seeing today is that it’s both high and rising fast. The CPI is efficient at telling us whether the overall tide is rising or falling and at what speed.

In June, the most recent CPI report indicates that we saw a monthly rise of 0.9%, up from 0.6% in May. The year-over-year rise of 5.4% was the highest for the CPI since 2008 and surpassed expectations for a 4.9% increase.

For some historical context, the CPI has not finished a year running over 5% since 1990. Looking at this chart, I empathize with those who think that inflation is a disease that we’ve somehow cured:

The Fed’s preferred measure

The Federal Reserve prefers to use the Personal Consumption Expenditures (PCE) metric when making policy decisions, rather than the CPI. According to Fed policy, they would like to see the PCE at or below 2% for a sustained period of time before raising interest rates or stopping the monthly purchase of $120 billion in mortgage-backed securities. This is why mortgage rates are currently so low.

The PCE has increased by 3.4% in the past year, which is higher than the Fed’s target. Powell said that inflation is likely to remain high in the next few months before going down.

It seems that the author is doubtful of the validity of the statement made by the Fed governor. Many other governors are start to disagree with the gospel, which suggests that inflation rates will be higher for a longer period of time. They are also saying that the Open Market Committee needs to act more quickly to raise rates and reduce MBS purchases.

So what does the actual data on the ground say?

Inflation is a lagging economic indicator, which means that it takes time for changes in the cost of raw materials to make it up the chain to the final selling price. The CPI and the PCE are two measures of inflation.

The Bloomberg Commodity Spot Index, which includes metals and agricultural commodities, is up 50% year-over-year and about 15% in 2021 thus far. This index tracks the prices of the stuff that goes into the stuff that everybody buys, so the rising prices may indicate inflationary pressures in the near future.

The Producer Price Index, which measures prices at the producer or manufacturing level, rose 1% in June, up from a 0.8% climb in May. The 1% rise was against a consensus expectation of just 0.5%. These numbers may look small, but in economics parlance that is a very large miss versus the consensus. Year-over-year, the PPI is clocking in at 7.8% growth, the fastest pace in more than a decade.

An event that never occurs in corporate finance is when companies’ costs go up without raising the final price for consumers. This is especially true when the economy is doing well. We can expect that the rise in Producer Price Index will result in a rise in the Consumer Price Index in the months ahead.

The Fed is in a difficult position because the data contradicts what they have been saying and people can see this for themselves. I think the Fed knows this but they will need to make changes gradually over the next year.

Many analysts believe that the Fed will have to lower interest rates next year instead of 2024. They think that the Fed’s aggressive rate increases will cause the economy to go into a recession, which will then cause inflation to go down faster than the Fed predicts. This will probably make the Fed change its focus from fighting inflation to trying to support the economy by cutting interest rates at the end of next year.

According to Mr. Cabana, the market is predicting that the economy will weaken at a faster rate than the Federal Reserve is anticipating. Additionally, the market believes that this will lead to a decrease in inflation, which in turn will cause the Federal Reserve to change its focus from controlling inflation to stimulating economic growth.

Stocks rates fell excessively on Friday, continuing the trend from the previous week. This caused investors to remove $4 billion from funds that buy U.S. shares within a seven day period ending on Wednesday, according to EPFR Global.

costs for companies and consumers go up when interest rates are higher, which usually hurts stock prices. This week, the Fed wasn’t the only central bank to raise rates. Central banks in Europe and Asia did the same thing.

Kate Moore, a managing director at BlackRock, believes that the Fed’s current projections for the economy are too optimistic and that the reality will be worse.

The Federal Reserve’s projection of a significant increase in economic growth next year compared to their forecast for this year does not match up with their plans to raise interest rates sharply. Barclays analysts said that the growth projection doesn’t make sense given that spending is slowing down and financial conditions are tightening. As rates go up, it becomes more expensive for companies to borrow money, which leads to less spending, fewer jobs, and higher unemployment.

The Federal Reserve wants to get rid of job openings without increasing unemployment too much, but some people think that the unemployment rate will be higher than the Fed’s prediction of 4.4% by the end of next year. For example, TD Bank forecasts 4.8% unemployment and Bank of America expects 5.6%.

Analysts expect inflation to fall more quickly because the economic outlook is worse. This is because a recession will cut consumer and business demand faster than a more mild slowdown. This also paves the way for the Fed to cut interest rates to support the economy. The Fed has said that it will only cut interest rates once it is confident that inflation is headed back to its target of 2 percent.

According to current forecasts, interest rates will be around 4.5% by the end of 2023, which is down from earlier in the year when it was projected to be around 4.7%. This implies that there will be a single quarter-point cut in interest rates sometime in the second half of the year.

Goldman Sachs’ bank analysts predict that interest rates will stay high next year, and inflation will be hard to control. Lauren Goodwin from New York Life Investments thinks inflation will stay too low for the Fed to cut interest rates, contrary to what the market is hoping for.

The Fed has to predict how rising interest rates will affect the economy, taking into account all the other global factors influencing it. These include the actions of other central banks, as well as Russia’s ongoing conflict with Ukraine, which affects food and energy prices. Additionally, some economies are facing impending crises.

The Fed committee that sets monetary policy has acknowledged the high levels of uncertainty about the future. In their forecasts, they are asked to rate the uncertainty of their projections relative to the levels of uncertainty over the past 20 years. All participants, across all forecasts, responded that the current levels of uncertainty are higher than they have been in the past 20 years. This is the first time that has happened since March 2020 and the onset of the coronavirus crisis.

No one, not even Jerome H. Powell, knows whether the current process will lead to a recession and, if so, how bad it would be.

Mr Cabana is concerned that the economy is being choked by the quick interest rate increases when there is such a high level of uncertainty.

He’s saying that the Federal Reserve is driving the economy too fast given how uncertain they are about the future. It’s like driving on a road not knowing where it’s going; the faster you go, the more likely you are to have an accident.

The risks of a policy mistake

If the Federal Reserve and other central banks around the world wait too long to combat inflation by raising interest rates, many important economists and former central bankers say it could be catastrophic.

If a policy mistake is made by waiting too long, there could be big disruptions to the housing market. For example, if the Fed is forced to raise rates 1% (or more!) within a month, the ripple effects would be fierce. Loan originators would freeze out amid a rush of applications trying to get in under the wire. Deal flow would slow to a snail’s pace. Affordability rates for homebuyers would go from 80% to 90% to 40% to 50%. In this scenario, average selling prices would probably drop—and they would, at minimum, stop rising at the clip they have been the past few years.

The bond market could see selling as investors flock to the treasury markets, driving prevailing rates higher than the Fed is comfortable with. This could lead to problems for the economy as a whole, especially for those who were overleveraged to begin with.