Fed Preview: Central Housing

On Dec. 12, the Federal Open Market Committee added the word "substantial" to describe the cooling housing market in its policy statement, and traders softly cooed, "doves, doves, doves."

At this week's policy meeting, a two-day confab beginning Tuesday, analysts and traders expect the opposite. Many believe the central bank will acknowledge the economy's faster-than-expected reacceleration, particularly in the housing market.

Although a more hawkish tone to this week's policy statement may be in the cards, a rate hike is still only a distant possibility. The housing market has stabilized, but it is still "not out of the woods," as so many commentators are fond of saying. Housing is still at the crux of the Fed's pause, even if the word "substantial" is removed from Wednesday's policy statement.

Indeed, with Treasury yields and mortgage rates climbing, the housing market's fledgling recovery is facing a new test.

"Housing vulnerabilities still act as a deterrent to tightening of Fed monetary policy," says Moody's chief economist John Lonski, referring not only to the still-large housing inventories, but also to the recent rise in delinquency rates among sub-prime mortgage borrowers. "The Fed does not want to risk finding out the consequences of pushing rates [up] right here."

The Test: Rates Jump, Mortgage Applications Fall

The Fed's decision to pause its two-year tightening campaign last August helped keep long-term interest rates low and was just the medicine the ailing housing market craved. Low rates plus granite countertops, fancy refrigerators, and/or a new car were incentives for home buyers who might have otherwise stayed on the sidelines.