Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / The Fed's Quiet Housing Squeeze
Transcript
- Lucas: Look at the ten-year Treasury yield right now sitting near five point one two percent. It feels like the market has finally accepted that the era of cheap money is over, but I think we are misreading what that actually means for the real economy. Luna: You mean beyond just higher monthly payments? Because everyone talks about affordability, but nobody seems to be talking about the freeze in transactions. Lucas: Exactly. The freeze. With the effective federal funds rate hovering at three point seven five percent and interest on reserve balances holding steady at three point nine zero percent, the cost of capital isn't just high; it's structurally locked in place. This creates a unique kind of paralysis in the housing sector that standard inflation models miss entirely. Luna: Right, because if you bought your house in twenty twenty one at a two percent mortgage rate, you aren't selling, so the supply chain is effectively jammed at the top end. Lucas: That is the core of it. We have a situation where inventory is artificially constrained not by a lack of builders, but by a lack of willingness from existing owners to trade their low-cost debt. It turns housing into a non-performing asset class for millions of households, draining liquidity from their balance sheets without them even realizing it. Luna: So the Fed sees sticky inflation in shelter costs, but they aren't seeing the potential deflationary shock that happens when these homeowners can't access their equity anymore. Lucas: Precisely. And look at the latest CPI data from early September. Core CPI is up to three hundred thirty eight point nine, which is stubbornly above the Fed's comfort zone. But the PCE price index tells a slightly different story with core PCE at one thirty point five, showing only marginal acceleration. The divergence suggests that while prices are still rising, the velocity of those price changes is slowing down. Luna: But does that matter if the underlying mechanism of wealth transfer is broken? If people can't move, they can't spend or invest elsewhere. Lucas: It matters immensely because it forces consumption into other areas. When housing equity is trapped, consumers don't stop spending; they shift it toward services and durable goods that don't require collateral. That keeps demand hot in sectors that are already prone to wage-driven inflation. Luna: Which brings us back to the labor market. We saw those warning signs in the recent JOLTS data about job openings cooling, but wages are still creeping up in tight labor segments. Lucas: Yes, and that is why the FOMC meeting next week is going to be critical. Kevin Warsh's recent commentary highlighted that there is room for a surprise, but I suspect the surprise won't be a rate hike. It will be a signal about the balance sheet. The Fed might need to address the liquidity crunch directly rather than just watching inflation tickers. Luna: You think they would intervene in the mortgage market? That seems outside their mandate. Lucas: Not the mortgage market directly, but the liquidity conditions that support it. Remember, the Fed controls the overnight rate and the quantity of reserves. If banks are hoarding reserves because of regulatory pressures, credit creation slows down exactly when housing needs it most to thaw out. Luna: So it's less about the rate itself and more about the plumbing behind it? Lucas: Exactly. And here is where it gets personal for our listeners. If you are holding variable-rate debt or considering a refinance, the current environment is punishing. The spread between short-term rates and long-term yields is compressing, but the risk premium for borrowers is expanding. Luna: I noticed that same dynamic in my own neighborhood. Everyone is staying put, which drives up rents, which feeds back into the shelter component of inflation. Lucas: That feedback loop is the hardest part for the Fed to break. They can raise rates to cool demand, but they can't force people to sell homes. So they are stuck in a bind where tightening doesn't solve the supply constraint, but easing risks reigniting the very inflation they just spent years fighting. Luna: It feels like we are waiting for a catalyst. Something has to give. Lucas: Usually, it is a shock to employment. But with the Dow currently at fifty two thousand four hundred seventy five and small caps in the Russell two thousand seven hundred seventy six holding steady, the labor market hasn't cracked yet. So the pressure remains purely financial. Luna: So what is the play for someone listening who has excess cash right now? Do they sit in Treasuries or try to buy property? Lucas: If you have excess cash, you are in a rare position of power. You are essentially offering liquidity to a market that is starving for it. But you have to be selective. Look for distressed assets where sellers are forced to move due to life events, not just market timing. Luna: Distressed implies pain. Are we sure that pain isn't going to spread to the broader economy soon? Lucas: We are not sure, which is why volatility in the VIX and the bond market is so elevated. The system is fragile, but it is not collapsing. It is grinding. Luna: Grinding is almost worse because it drains patience. Lucas: It is. And that is why I want to take a quick second to talk about how we keep this analysis running daily. If walking through the economy with us has made something click, consider supporting the show. A couple of dollars a month is genuinely what keeps these deep dives possible. You can find us at buy me a coffee dot com slash fexingo — that's F. E. X. I. N. G. O. Luna: Yeah, it really helps us dig into the data like this instead of just skimming headlines. Lucas: Thanks for that. Now, getting back to the housing squeeze, let's look at the regional breakdown. It's not uniform across the country. Luna: No, definitely not. Sun Belt states are feeling the pinch much harder than Rust Belt areas with stable industrial bases. Lucas: Right. In places like Arizona or Nevada, where price appreciation was hyper-accelerated during the pandemic, the correction is sharper. Homeowners there are underwater or close to it, meaning they can't sell without bringing cash to closing. That eliminates ninety percent of the market activity in those zip codes. Luna: So the national average hides a lot of local distress. Lucas: It completely. And since those markets drive a significant portion of new construction permits, a slowdown there signals future oversupply issues once the cycle eventually turns. Luna: So we might see a glut of new homes in three years while existing stock remains frozen today. Lucas: That is a plausible scenario. It puts builders in a tough spot. They have to lower prices to move units, which hurts margins, but they can't stop building because leases on lots expire. Luna: It sounds like a classic stagflationary setup for the real estate sector specifically. Lucas: High costs, low volume. Exactly. And this brings us to the broader implication for consumer confidence. When people feel locked out of their primary asset, they tend to become more conservative with spending. Luna: Even if they aren't planning to sell? Just knowing their net worth is tied up in illiquid bricks? Lucas: Yes. Psychological wealth effects are real. If you believe your house is worth two million but you can't touch a dollar of that equity, you live like you have less money. That drags on retail sales and service spending. Luna: So the Fed's fight against inflation might actually succeed because consumers are voluntarily pulling back, not because rates did the work. Lucas: That is a dangerous outcome for the Fed. They want soft landings, not sudden stops. If the housing lock-in causes a sharp drop in aggregate demand, we could see unemployment rise faster than expected. Luna: Then maybe the 'surprise' Warsh mentioned is actually a dovish pivot triggered by a labor shock we didn't see coming. Lucas: It is possible. But until then, the data points to a continued grind. The ten-year yield staying above five percent keeps the pressure on. Luna: Do you think investors are pricing in that labor shock risk yet? Lucas: Not fully. The options market is still skewed toward calm, but that complacency usually breaks quickly when earnings reports start reflecting the housing drag. Luna: So we watch October earnings closely? Lucas: We do. Specifically builder margins and retailer guidance regarding big-ticket items. That is where the truth about consumer liquidity will hide. Luna: Interesting. It seems like the quiet squeeze is about to get loud. Lucas: It already is. We just have to decide if we are watching the silence or the noise. Luna: I guess we keep an ear on both until the Fed speaks next week. Lucas: Agreed. Until then, check your own balance sheets and see where your liquidity actually sits.