Inflation just reached its highest point in three years.
The Bureau of Economic Analysis released the May Personal Consumption Expenditures (PCE) price index on June 25, which showed that year-over-year inflation increased by 4.1%.
Sure, rising inflation is bad news all around. But what does the latest PCE have to do with mortgage rates?
The PCE is the Federal Reserve’s preferred metric for tracking inflation, according to the Federal Reserve Bank of Cleveland. The central bank watches this index to see whether inflation moves closer to its target of 2%.
Sky-high inflation is bad news for the federal funds rate, and the Fed could take action that will ultimately push up mortgage rates.
“The rate of inflation is now the highest it has been in three years and almost twice what it was a year ago,” Melissa Cohn, Regional Vice President of William Raveis Mortgage, told TheStreet. “When inflation rises, so do mortgage rates.”
How the PCE impacts mortgage rates
Another popular tool for measuring inflation is the Consumer Price Index (CPI). However, the Fed prefers the PCE, particularly the “core” PCE, which eliminates categories with volatile pricing, such as energy and food.
Removing these unsteady categories gives the Fed a better idea of how the economy is doing overall. The core PCE increased to 3.4% in May, up from 3.3% in April.
Now that the May PCE has shown a high inflation rate, experts have even more reason to believe that the Fed will hike the federal funds rate this year. The next meeting in July may be too soon since the central bank is keeping an eye on geopolitical issues. But the CME FedWatch tool foresees a hike in September.
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The federal funds rate doesn’t directly impact mortgage rates, but it certainly indirectly affects them.
Mortgage rates typically follow the 10-year Treasury yield more closely than the fed funds rate. However, many of the same factors impact both of these numbers.
Investor and consumer sentiment about the Fed also affects mortgage rates. When people expect the FOMC to hike its rate, mortgage rates typically increase ahead of the Fed meeting.
BRENDAN SMIALOWSKI / Getty Images
Where mortgage rates are headed after the inflation news
Although Cohn noted that inflation typically drives up mortgage rates, she also said the June 25 PCE could have been much worse for rates if it weren’t for falling oil prices.
“As the war in Iran winds down, the price of oil has dropped significantly and is now nearly back to pre-war levels,” she told TheStreet. “This drop will help to bring down the rate of inflation — but it will take time.”
Cohn believes lower oil prices will continue to help mortgage rates decrease. Not everyone agrees, though, and the answer isn’t crystal-clear.
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“If Iran continues to threaten the Strait of Hormuz shipping, a ceasefire alone may not be enough to move bond markets or mortgage rates,” Senior Economist Jake Krimmel wrote for Realtor.com. “Unfortunately, both inflation and mortgage rates appear to be staying higher for longer.”
Krimmel isn’t the only one who expects the PCE to keep mortgage rates high.
“The more likely story for the second half of the year is volatility around a higher-for-longer range, rather than a meaningful decline in mortgage rates,” Odeta Kushi, Deputy Chief Economist at First American Financial Corporation, told Mortgage Professional America.
“If inflation remains sticky and investors continue to demand compensation for inflation risk, mortgage rates may stay elevated,” she continued.
After considering both opinions, here’s what I believe: Inflation data will keep mortgage rates relatively high — but thanks to oil prices and the situation in the Middle East, rates probably won’t increase as sharply as they would have otherwise.
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