The May inflation report shows that inflation is continuing to cool, which could be the nudge the Fed needs to set the stage for impending rate cuts at their June meeting. That would be good news for the housing market, because it would bring mortgage rates down–at least slightly.
Inflation continued to cool in May, with the latest CPI report showing that price increases have slowed more than expected. That’s good news for homebuyers because it means the Fed is more likely than not to cut interest rates in September, and brings back a slight possibility that they start cutting earlier than expected, as soon as July.
The key metric of core inflation rose 0.16% from the prior month (3.4% YoY) in May, well below expectations. That is the lowest monthly increase since August 2001. Headline inflation, which includes volatile food and energy prices, rose 0.0% MoM (3.3% YoY), also below expectations of 0.1% MoM (3.4% YoY), due to large declines in energy prices.
A turnaround in motor vehicle insurance costs and decline in airfares drove the drop in inflation relative to earlier this year. Shelter inflation (both rent of primary residence and owner’s equivalent rent) remained at 0.4% MoM, similar to previous months, still not fully reflecting the slowdown in market rent data over the past 18 months, meaning there is reason still to believe that inflation will fall further.
Depending on how the PPI data comes in tomorrow, core PCE, the Fed’s preferred inflation metric, may come in below the Fed’s target monthly pace. That would set the stage for the cutting cycle to start late summer/early fall. While the January to March inflation readings were uncomfortably high, they started to moderate last month. With today’s May data, the high readings from the first quarter look increasingly like the result of residual seasonality post-COVID, rather than inflation getting stuck. That means start-of-year effects are not being fully accounted for by the seasonal adjustment processes used by government statistical agencies, and are producing high inflation readings.
If the Fed starts cutting rates in September, they’re more likely to squeeze in two rate cuts this year. All of this depends on monthly inflation data. The Fed has said that if core PCE readings come in at their target, they can cut rates. But there are good reasons to believe the PCE data doesn’t reflect current economic conditions; ideally, the Fed would use that data but also be flexible about ignoring parts of it that have known issues. There is still one more inflation report before the July Fed meeting, and three before the September Fed meeting.
Investors will be paying close attention to whether the Fed predicts one or two rate cuts this afternoon in their new set of projections. Officials will have a chance to digest this new inflation data before finalizing their individual forecasts today. They will also have in their minds the bevy of recent economic data that, with the exception of the establishment survey in the jobs report–which showed more job creation than expected in May–has been pretty weak, indicating that high rates continue to weigh on the economy. That means they may be more likely to lean toward two rate cuts. The Fed is meeting later today, which will give us a better sense of the rate-cut timeline.
This could boost housing-market activity. For homebuyers and sellers, today’s inflation data points to slightly lower mortgage rates in the near future as the Fed likely solidifies its plans for cutting interest rates. That could bring a much-needed boost to the housing market in the later part of the year when the housing market normally slows down.
