Why Jerome Powell is going to focus on stagflation

Less than two years ago, Federal Reserve chair Jerome Powell stood before reporters and famously dismissed the most dreaded portmanteau in economics. “I don’t see the ‘stag’ or the ‘-flation,’ actually,” he said in May 2024.

Today, as Powell nears the end of his term in May, that specter has returned. Confronted by a painful combination of sluggish economic growth and stubbornly persistent price pressures, the Federal Reserve is pivoting its focus toward a phenomenon the US economy has largely avoided since the 1970s: stagflation.

For mortgage originators who briefly celebrated rates dipping below 6% earlier this year, the central bank’s shifting calculus signals a complex and potentially volatile spring housing market.

The anatomy of ‘stagflation-lite’

The optimism that fueled financial markets late last year has been rapidly overshadowed by a cascade of sobering data. The Federal Reserve is now caught in a vice between its dual mandates of price stability and maximum employment.

• The ‘Stag’ (stagnation): Sluggish recent GDP growth and a labor market that is showing signs of cooling have prevented the Fed from simply ignoring economic weakness.
• The “Flation” (Inflation): Despite early progress, Core PCE inflation has remained stubbornly sticky. Adding fuel to the fire, geopolitical tensions have kept global energy and shipping prices elevated, threatening to reverse the hard-won disinflationary trends of the past two years.

With the Federal Open Market Committee (FOMC) holding the federal funds rate steady and halting brief rate cuts, the bond market has already begun to price in a "higher-for-longer" reality.

What this means for mortgage originators

The mortgage industry operates at the mercy of the 10-year Treasury yield, which serves as the benchmark for 30-year fixed-rate mortgages. When stagflation fears grip the bond market, yields rise to compensate for the eroding purchasing power of inflation, dragging mortgage rates up with them.

We are already seeing this play out in real-time. After briefly touching multi-year lows in late February, average 30-year fixed mortgage rates have rebounded.

For originators, a stagflationary environment introduces three primary challenges:

1. The stalled refinance boomlet: The sub-6% rates triggered a brief flurry of refinance activity from borrowers who purchased at the late-2023 peak. A sustained upward drift in rates will quickly close this window.
2. A resurgent lock-in effect: Affordability remains heavily constrained. Home prices have not meaningfully corrected, and an uptick in borrowing costs will only harden the resolve of existing homeowners holding sub-4% pandemic-era rates, further suppressing spring inventory.
3. Dampened consumer confidence: High inflation erodes real wages, while slowing economic growth stokes job insecurity. This psychological headwind makes prospective buyers hesitant to commit to 30-year liabilities, even if they can qualify on paper.

Navigating the spring market

Originators must adapt their strategies to a market defined by rate volatility and economic uncertainty. Here is how loan officers can position themselves to guide clients through the shifting dynamics:

• Promote Rate Locks: With inflation expectations driving up the 10-year Treasury yield, encourage clients to utilize 90-day rate locks or float-down options to protect against sudden geopolitical rate spikes.
• Focus on Credit Quality: Sluggish economic growth naturally increases recession fears. This may lead to tighter underwriting standards from lenders anticipating higher defaults. Pre-qualify borrowers more rigorously and target prime buyers who have highly stable incomes.
• Manage Expectations: The Fed's rate pauses dampen hopes for immediate, steep drops in short-term borrowing costs. Counsel buyers not to "wait for the bottom." Emphasize that current rates are still historically solid compared to the extreme volatility of the past three years.

The path forward

Jerome Powell’s primary objective for the remainder of his term will be preventing the temporary shocks of energy prices and trade policies from becoming entrenched in long-term inflation expectations.

For the mortgage industry, the era of relying on a swift, uninterrupted slide in rates is over. Success will belong to originators who can effectively guide their clients through the complexities of a stagflationary environment, focusing on financial education, precise timing, and proactive pipeline management.

What is stagflation?

Stagflation is an economic term created by combining the words stagnation and inflation. It describes a rare and highly challenging economic condition where three negative trends occur simultaneously:

1. Slow economic growth (stagnation)
2. High unemployment
3. Rising prices (inflation)

Typically, a slowing economy reduces consumer demand, which causes prices to drop (or at least stop rising). Stagflation breaks this normal economic rule, leaving consumers and policymakers in a very difficult position: your money loses its purchasing power at the exact same time that jobs become harder to find and wages stall.

The economic paradox

To understand why stagflation is a nightmare for central banks like the Federal Reserve, it helps to look at traditional economic theory. For a long time, economists believed that inflation and unemployment had an inverse relationship. If the economy was booming and unemployment was low, inflation would go up. If the economy was shrinking and unemployment was high, inflation would go down.

Stagflation throws this trade-off out the window. Because prices are rising while the economy is slowing, central banks are trapped. If they lower interest rates to stimulate the economy and create jobs, they risk making inflation even worse. If they raise interest rates to kill inflation, they risk plunging the already-weak economy into a deep recession.

Stagflation is usually caused by a "supply shock"—a sudden event that drastically increases the cost of producing goods or limits the supply of a critical resource (like a war severely disrupting global oil supplies). Because it costs much more to produce goods, prices spike. Simultaneously, businesses can't afford to produce as much, so economic output drops and they lay off workers.

Why stagflation matters to the mortgage industry

For mortgage originators, real estate agents, and homebuyers, stagflation creates a uniquely hostile environment. It combines the worst aspects of an economic boom (high interest rates) with the worst aspects of a bust (job insecurity and low inventory).

Here is exactly how stagflation impacts the mortgage market:

1. It drives mortgage rates up. The mortgage industry operates at the mercy of the 10-year Treasury yield, which serves as the benchmark for 30-year fixed-rate mortgages. Inflation is the enemy of bonds. When inflation runs hot, the purchasing power of fixed returns is eroded. To compensate for this risk, investors demand higher yields. As the 10-year Treasury yield climbs to outpace inflation, mortgage rates are dragged up right alongside it.

2. It kills purchasing power (the affordability squeeze). In a normal inflationary environment, wages eventually rise to match the cost of living. In a stagflationary environment, economic growth is stagnant, meaning wages stay flat while the cost of groceries, gas, and housing goes up. This severely restricts how much house a buyer can afford. Their debt-to-income (DTI) ratios worsen not because they took on more debt, but because their living expenses surged while their income stalled.

3. It deepens the "lock-in" effect. When the economy feels shaky, people crave stability. If a homeowner secured a 3% or 4% mortgage rate a few years ago, the prospect of giving up that historically low payment to buy a new home at a 6.5% or 7% rate becomes unthinkable—especially when the broader economy feels precarious. This paralyzes the market, drastically reducing the inventory of existing homes for sale.

4. It triggers stricter lending standards. Because the "stag" in stagflation means a weak economy and rising unemployment, banks and lenders become increasingly nervous about borrower defaults. To protect themselves, lenders often tighten their underwriting guidelines. They may require higher credit scores, larger down payments, or more extensive proof of income reserves, weeding out marginal buyers who might have qualified in a healthier economy.

Ultimately, stagflation matters to mortgages because it forces buyers to navigate peak borrowing costs using weakened personal finances, all while choosing from a historically low supply of homes.