July 29, 2022

Inflation is bad. It has been worse

Faced with strong and persistent inflation, the Federal Reserve has now raised its baseline interest four times in 2022 - the first such hikes since 2018. All indications are more increases are to come.

The Fed will likely continue aggressively raising rates until inflation is brought under control, which is one of its primary missions.

All though many economic indicators point to slowing inflation, consumers have yet to see much relief. June's consumer price index (CPI) rose to 9.1%, the fastest pace of growth in more than 40 years.

For homebuyers, the hikes are also the primary culprit driving up mortgage interest rates. In June they reached their highest level since 2009.

Mortgage rates are more than 2 percentage points higher than last year at this time, and homebuyers are paying roughly 50% more each month to buy the same home. Housing activity has already begun to slow, though home prices in general are still rising - up 13% from the same time in 2021.

Further sales declines are expected, but unless there is a deep and sustained economic downturn, most analysts expect home prices to continue to move higher on average.

However, a growing percentage of sellers in some of the hottest pandemic markets - including Boise, ID, Portland, OR, Salt Lake City and Seattle - are already beginning to slash asking prices as competition tapers off.

Those 40 years old and younger probably cannot appreciate it, but inflation has been worse – much worse. After a series of harrowing economic events in the late 1970s and early 80’s, prices at one point were rising at an alarming annual rate of 14.5%.

Then as now, the Fed pushed back with higher interest rates. By late 1981, 30-year mortgage interest rates topped out at 18.45%. At first, some consumers were able to take advantage of the higher returns on savings, but not for long.

The average house cost $82,500 back then. Those who financed 80% of the cost at 18.45%, paid a monthly mortgage payment of $1,019, with $400,000 going to interest over the life of the loan. Does not sound that bad? Remember, those was 1981 dollars.

To put it in perspective, imagine you bought a home today at the 2021 median of $322,700, with a 20% down payment. If you financed the remaining 258,160 at 18.45%, your monthly payments would be $3,986, not including tax and insurance.

You would pay $1.43 million over 30 years, with about $1.18 million – 82% of your payments - going to interest.

Amid today’s mortgage market, fretting usually begins when mortgage interest rates top 5%. Ten percent, let alone 18.45% is hard to conceive.

And it was not just housing. As is typical, the ballooning Fed rate trickled down to all lending rates. Demand for borrowing nearly dried up completely. With little business re-investment, recession followed. Unemployment grew to a rate of 10%.

Although jobs and consumer spending remain robust, some worry that today’s rising borrowing costs could cause a sudden recession. It is hard to predict.

Current Fed Chair Jerome Powell believes the country can navigate the inflation quagmire properly this time, leading to an economic “soft landing” without a downturn or a significant increase in joblessness.