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Barkin: Inflation high, but Fed has tools to contain it

Tom Barkin agrees — inflation is too high. But he also says the Fed has the authority to get it back on the right track.

That’s what the president and CEO of the Federal Reserve Bank of Richmond told the Richmond chapter of the Risk Management Association on Tuesday at Triple Crossing Beer, a brewery in eastern Henrico County. “The Fed has the tools to contain inflation over the medium term, and we are committed to returning inflation to our target,” he said. ” We are meeting the test we face and have made clear we will do what it takes.”

Barkin’s talk came in the wake of the Federal Reserve Board of Governors’ June 15 decision to raise the target interest rate by three quarters of a percentage point — the highest increase since 1994.

Barkin said that the move was necessary due to higher rates of inflation than previously anticipated.

Americans need to wait for the market to settle down from shocks caused by the pandemic, the Russian invasion of Ukraine and supply and labor shortages, he said. The current economic moment — with record-breaking inflation, gas prices over $5 a gallon and rising rents and home prices — feels particularly unstable because of the relative stability of the economy prior to COVID, Barkin acknowledged in a Q&A session following his speech.

“I think with 20/20 hindsight, [the decade before COVID was] an unbelievably stable time for inflation, for GDP, for job growth, for an economy in general,” he said. “And we’re now two years into a quite unstable time. I think things need time to pivot back and forth to get back to stability. Continued volatility around some of these economic indicators [is] a more likely scenario. I do think that means we’re going to have some months or maybe even some quarters [when] our inflation points are actually well below where they were before COVID. But then you’ll have months where they’re high.”

Although Barkin was not willing to say a recession is definitely coming, as far as many Americans are concerned, it seems pretty likely. Citing the University of Michigan’s most recent consumer sentiment survey, Barkin noted that consumer sentiment fell to its lowest level on record and the percentage of small business owners surveyed  expect better conditions over the next six months was at its lowest level in the history of the survey.

Speaking specifically about Virginia, Barkin said that heavy government and military spending would help Northern Virginia and Hampton Roads avoid the worst impacts if the U.S. economy hit a recession. “I think the rest of the economy is relatively diverse, and it’s going to be affected a lot like the rest of the country. The question is going to be, ‘How deep does it go?'”

Many recall the 2008 Great Recession, a “very significant financial crisis,” he noted, “which, fingers crossed, doesn’t seem to be in the cards today.” He compared today’s economy to those that preceded the shorter recessions of 2001 and 1994, which affected certain sectors but were not as broadly destructive.

In his speech, Barkin also noted that fiscal support from the pandemic is waning and now it’s moving the Fed to raise interest rates, which slows the economy by making it more costly to borrow. “Historically, eight of the last 11 Fed tightening cycles have been followed by some sort of a recession,” he said. That markets are skittish is understandable, he said, because the Fed hasn’t moved this quickly to adjust rates in more than 20 years. Couple that with supply-chain challenges, pandemic-era shortages, the war in Ukraine and lockdowns in China, and even more unknown factors swirl.

But, he points out, consumer spending — responsible for two-thirds of the economy — is “quite healthy” and supported by strong personal balance sheets, excess savings accrued during the pandemic and the ability to do things like book trips again. He added that unemployment is historically low at 3.6%, and interest rates have not reached levels that constrain the economy.

“Barring an unanticipated event, I see rising rates stabilizing any drift in inflation expectations and in so doing, increasing real interest rates and quieting demand,” Barkin said. “Companies will slow down their hiring. Revenge spending will settle. Savings will be held a little tighter. At the same time, supply chains will ease; you have to believe [computer] chips will get back into cars at some point. That means inflation should come down over time — but it will take time.”

Barkin noted that the economy is out of balance today because stimulus-supported excess demand overwhelmed supply chains that are already constrained, but going back to normal means putting more products back on shelves, seeing restaurants and stores fully staffed, and cars back on auto lots.

“Most importantly, moderating demand has a higher purpose squarely in our mandate: containing inflation,” Barkin said. “The Fed is on a path to return inflation back to normal levels. We have the credibility with households, businesses and markets required to deliver that outcome. We may or may not get help from global events and supply chains. There is of course recession risk along the way, but there’s also the prospect of the economy returning closer to normal.”

Rising interest rates not enough to deter homebuyers

Even the Federal Reserve hiking interest rates likely won’t be enough to cool down the hot real estate market in Virginia, experts say.

In an attempt to slow the highest inflation rates in 40 years, Fed officials voted on March 16 to raise the benchmark federal funds rate by a quarter percentage point to a range between 0.25% and 0.5%, the first rate increase since 2018, according to The Wall Street Journal. It’s expected to rise to about 2% by the end of the year, slightly higher than before the pandemic. In March 2020, the Fed slashed rates to nearly zero to boost the economy amid pandemic shutdowns. 

“The increase in the federal funds rate was well telegraphed by the Federal Reserve, so no one was surprised,” said Virginia Realtors Chief Economist Lisa Sturtevant. “And so to that extent, we know that when the Fed raises the short-term borrowing rate, it ultimately then works into all types of rates, including mortgage rates, but the things is, this rate [hike] was anticipated and to a large extent, it’s already been baked into current mortgage rates.” 

Rates ticked up March 17, a sign of what the next few weeks could look like, in terms of volatility in mortgage rates, she noted. Last year, rates were not expected to rise much past 4% but this year it could be closer to 5% by the end of 2022. 

“I think all this is to say that rising mortgage rates, along with challenges with rising affordability issues, means that we’re likely to see a little bit of a cooldown in demand in the housing market,” Sturtevant said. 

That’s not necessarily a bad thing, she pointed out, as it would “take a little bit of the frenzy out of the market [and] allow the market to return to a little bit more normal conditions.”

But that doesn’t mean the market will have a correction.

“The underlying fundamentals remain pretty strong in terms of the demographics … [and] the economy in Virginia is sort of chugging along pretty well. So I think we’ll see a slowdown in demand as a result of higher mortgage rates, but more of a softer sort of demand, rather than any sort bottom-falling-out market,” Sturtevant said.

Virginia Mortgage Banking Association President Kevin Darcey and Ryan McLaughlin, CEO of the Northern Virginia Association of Realtors, both look at the rate hike from a historical perspective.

“Where rates are right now is going to be in a very similar spot ratewise where we were back in 2018, when the average was roughly 4.54%,” Darcey said about mortgage rates. “That’s probably where we’re going to end up — somewhere in that range.”

January’s median home sales price was $337,500, according to Virginia Realtors. Each half-point increase in rate will change the monthly mortgage payment by about $100, Darcey said.

“I think we’re going to find that in certain markets, that may not have a large impact, but for some, such as first-time homebuyers, there’s going to be an affordability issue, or it will eliminate some buyers from being able to purchase a home, so it’s definitely a concern,” Darcey said. 

The combination of homes being sold over list price and an increase in rates will result in a little bit of a slowdown, he said.

McLaughlin noted the historical context is important when looking at rates going up. In the 1980s, the home lending rate climbed as high as 22%.

“We’re expecting by the end of the year, mortgage rates should be around 4.3%,” he said. “While that’s up, in the big picture, long-term rates are still very competitive when it comes to buying a home.” 

The bigger problem, however, is the shortage of inventory. 

At the end of January, there were around 12,000 active listings in the state, according to Virginia Realtors — about 5,000 fewer than this period in 2021 and decrease of nearly 27%. 

There’s slightly more than three-quarters of a month’s supply of homes now, a historic low, according to Jon McAchran, principal broker of AtCoastal Realty and secretary of the Real Estate Information Network (REIN) multiple listing service in Hampton Roads. By contrast, a balanced market will have five to seven months of supply, he said.

He doesn’t think the rising interest rates will ultimately make a big difference. 

“When you put a house on the market and get 50 showings and 20 offers in a day or two, that’s the biggest testimonial of the supply and demand metric,” McAchran said. “I personally don’t think things are going to slow down until this supply and demand issue gets more under control.” 

He encourages the agents and brokers he works with to stay educated on the market now, and on what it’s been like in the past. 

Reggie Copeland, principal broker of Fairfax-based C.R. Copeland Real Estate and president of the Northern Virginia Association of Realtors, echoed that sentiment. 

“The key is to be educated with some of the different strategies helping us to work with buyers and sellers and realize that, even though it’s a great market for sellers, [it] doesn’t mean you’ll get multiple offers,” he said. 

Copeland thinks it will take a couple of rate hikes before there’s a significant impact on the Northern Virginia real estate market.

The Fed has six more rate hikes planned before the end of 2022.

“There’s so many buyers in the market, I don’t see it causing buyers to back out,” Copeland said, but he encourages buyers to be ready to close within two or three weeks. 

“I think everybody knew the change was coming. The big thing [is] we have to live in the moment and buy or sell based on what’s happening in the market, not what’s going to happen in six months or a year. It’s unpredictable. No one knows.”