Facing a squad of U.S. senators firing question upon question Nov. 14, Janet Yellen might have been surprised that no one asked her the obvious one: Can the Federal Reserve taper its $85-billion-a-month asset purchase program without compromising the housing recovery?
In her first congressional hearing as nominee to become the world’s most powerful central banker, Yellen didn’t seem in a hurry to scale back the Fed’s massive bond buys, also known as quantitative easing (QE). There is no evidence that the policy, which encourages borrowing by keeping long-term interest rates low, has inflated dangerous bubbles in the stock market and residential real estate, she said. She did acknowledge, however, that QE “cannot go on forever.” And when the time comes for the exit, the masterful trick she will have to perform is letting rates appreciate while preserving the housing momentum.
It’s a tall order, even for a central banker as experienced as Yellen, who has been the Fed’s vice-chair until now. The housing market revival, propelled by cheap mortgages, has been a tailwind for the entire economy. The Fed’s mere mention of trimming QE, though, sent mortgage rates up by a full percentage point this summer. Home sales fell, and real estate prices cooled.
Still, there are at least two reasons to think that Yellen can have her cake and eat it too—that is, oversee higher long-term rates and a healthy housing market. For one, homes in most of the U.S. “are still the deal of the decade,” says TD economist Beata Caranci. Let’s say that, over the next two years, the QE taper pushes rates on the most popular 30-year mortgages up to 5.5%, from 4.5% today, and home price growth slows to 5% year-over-year from the current 12%. Financing a home purchase in most of the U.S. would still be cheaper or in line with what it was through the pre-bubble 1990–2003 period, says Caranci.
Rising interest rates could also paradoxically make it easier for some first-time homebuyers to qualify for a mortgage. Rattled by the financial crisis, lenders have avoided new mortgage applicants to focus on homeowners refinancing existing mortgages. After last summer’s mortgage rate hike, though, refinancing activity dropped 60%. That may explain why some banks have loosened lending standards, as the Fed’s latest bank lending survey shows. Yellen’s task, it seems, is unenviable but not impossible.