It’s hot outside, but inflation is cooling. June’s CPI report is good news for the housing market, as it means the Fed is very likely to cut interest rates at their September meeting, the anticipation of which should push down mortgage rates immediately.
Lower-than-expected inflation in June cements a September rate cut, barring an unlikely spike in inflation in the next two months. In fact, today’s CPI data, along with the recent uptick in unemployment, suggests the Fed should cut at their July 31 meeting–but they are unlikely to surprise markets that way.
Core CPI inflation for June came in soft at 0.1% MoM (3.3% YoY), below expectations of 0.2% MoM (3.4% YoY), and the lowest since April 2021. Unrounded, the June MoM core CPI reading was 0.06%, meaning it almost rounded down to 0%. Headline CPI, which includes the volatile food and energy categories that the Fed prefers to ignore, was -0.1% MoM (3.0% YoY), also below expectations of 0.1% MoM (3.1% YoY). With such a low core CPI reading, core PCE, the Fed’s preferred gauge of inflation, is likely to come in near 0% later this month, if we don’t get an unexpected surprise with core PPI tomorrow.
The long-awaited drop in shelter inflation finally happened, driving much of the unexpected softness today. Overall shelter inflation dropped from 0.4% MoM to 0.2% MoM, with rent of primary shelter dropping to 0.2% MoM and the controversial owner’s equivalent rent (an attempt to account for housing inflation for those who own their homes and have fixed housing costs) category dropping to 0.3% MoM. Importantly, shelter inflation coming down should be sticky, not volatile, meaning that we should not expect this category to put upward pressure on overall inflation in coming months as it had been doing the last two years.
With three months of decent inflation readings, the most recent two of which were very low, the Fed should be “sufficiently confident” that inflation is on its way back to target. That means they can start their cutting cycle. Indeed, given the recent weaker economic data overall, particularly in the labor market where the unemployment rate rose to 4.1% in June, there is little reason to have such a restrictive stance on monetary policy. With the Fed funds rate at 5.5% currently, the economy is experiencing about 200-300 bps of restriction, meaning the Fed funds rate is about 2-3 percentage points above a rate that would neither stimulate nor constrict the economy. With a labor market that is slowing meaningfully, it almost doesn’t make sense to wait until September to make the first cut. The Fed could–and perhaps should–cut at its meeting on July 31. The reason why it is likely to wait is that post-financial crisis, the Fed prefers to give markets ample time to price in changes to monetary policy and they likely don’t feel they have enough time to gradually change their language and set expectations before July 31.
This is good news for the housing market. We are likely to see the lowest mortgage rates since March today. Ten-year treasury yields are down about 10 bps right now, and futures markets have now priced in near-certainty for a September rate cut. Given the fundamentals of this inflation report, we are more likely than not to get softer inflation reports in the coming months, implying lower mortgage rates in the second half of this year.
