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Mortgage Rates vs. CPI: Less Inflation = Lower Rates


While it seemed mortgage rates just couldn’t catch a break, a positive CPI report has led to a huge rally.

This is one of the bright sides to a decidedly negative environment, where if and when good news finally does materialize, it can make a big impact.

That good news was a Consumer Price Index (CPI) report that showed inflation slowing in October from September.

As such, bond prices rallied and corresponding yields fell, allowing interest rates on long-term mortgages to improve.

Long story short, 30-year fixed mortgage rates are back below 7%, and even in the mid-6% range after moving above 7.25% earlier this month.

Why Does CPI Matter to Mortgage Rates?

There are a number of factors that help determine the price and direction of long-term mortgage rates like the popular 30-year fixed.

But a big one is inflation, which at the moment has taken center stage. Mortgage rate watchers and the Fed have been fixated on inflation lately.

It is, after all, why mortgage rates more than doubled from around 3.25% to start the year to around 7% this week.

In short, the Fed began purchasing hundreds of billions in mortgage-backed securities and treasuries to lower interest rates and spur more lending, known as Quantitative Easing (QE).

This allowed mortgage rates to drop to record lows as the Fed bought up as much as lenders could churn out (they created constant demand).

However, in doing so they increased the money supply and that led to years of easy lending and perhaps speculation.

It couldn’t go on forever, but went on longer than anticipated due to the pandemic, leading to rampant inflation.

And so early this year the Fed began to tighten via Quantitative Tightening (QT), with a series of big rate hikes.

This pushed mortgage rates up at an unprecedented rate as they dealt with inflation head on.

To measure the effectiveness of these rate hikes, we look to the CPI report to determine if consumer prices are rising or falling.

Latest CPI Report Showed Slowing Inflation

The latest Consumer Price Index (CPI) could be a sign that the Fed’s aggressive rate hikes are finally taking a legitimate bite out of inflation.

And if inflation is indeed slowing, interest rates can come down, especially since they’ve been so elevated lately.

The index for all items less food and energy rose just 0.3 percent in October, after increasing 0.6 percent in September.

In other words, conditions improved markedly after that reading was 0.6 percent for two months in a row.

And reduced price increases mean inflation could be slowing, which is great news for interest rates.

It was enough for bonds to rally, with the 10-year treasury yield falling a sizable 31 basis points (bps) at last glance.

The 10-year is now at 3.84%, down from 4.15% yesterday, a big move that brings it back to levels seen in early October.

That was apparently enough for mortgage lenders to reduce their mortgage rates from around 7% to close to 6.625% or even 6.5%.

That’s a massive one-day move, even if mortgage rates remain well above levels seen earlier this year.

And it could be a sign that mortgage rates may have peaked, and could begin to settle back down into say the 5% range if all goes well.

This Is Just One CPI Report, It May Not Signal a Trend

Before we get too excited, it’s probably important to point out that this is just one CPI report.

In July, the CPI index for all items less food and energy also rose just 0.3 percent after rising 0.7 percent in June and 0.6 percent in May.

So we’ve seen this happen before, and then resume its upward trajectory. That means the Fed’s inflation fight could still be long from over.

As such, this could just be a temporary reprieve for mortgage rates, before they reach even higher highs, perhaps 8%.

At this point, nobody really knows what the longer-term trend is, but they’ll take the good news today.

I should add that mortgage lenders will likely be cautiously optimistic here, and may not pass on all the savings to consumers just yet.

Sure, mortgage rates are lower, but they won’t go out of their way to offer the full discount until they see real proof that inflation has cooled.

Nonetheless, this is a positive development and one the Fed wanted to transpire, a result of their many rate hikes.

If CPI continues to improve, it would signal a cooling economy that could foster lower interest rates on home loans and other consumer loans.

It could also rationalize the Fed’s plan to raise its fed funds rate at a slower pace, from 75 basis points at a time to 50 points and then 25 points.

And by early 2023, perhaps stop raising rates and even think about lowering them.

This could bolster the case for sub-5% mortgage rates by next year. Just don’t be surprised if mortgage rates go back up again in the meantime.

Update: More positive CPI reports have since come out, with the latest for December 2022 showing a top line decline of 0.1%, the best showing since April 2020.

However, excluding food and energy, core CPI rose 0.3%. So it’s still unclear if we’ve truly turned the corner on inflation.

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