A mild inflation reading in July’s CPI report will leave mortgage rates largely unchanged as the Fed is already on its way to cutting rates at its September 18th meeting. Shelter inflation drove all of the increase in inflation from last month, but it’s outdated, meaning underlying inflation is actually lower than reported in the CPI. The balance of risks has now shifted away from high inflation to a weakening labor market, so the September 6th jobs report will determine if the Fed cuts by 25 bps, or the 50 bps markets are hoping for.
Core inflation rose 0.17% from the previous month (3.2% from a year ago), as expected. Including the volatile food and energy categories, headline CPI rose 0.2% from the previous month (2.9% from a year ago), also in line with expectations.
Shelter inflation drove all of the increase in inflation from last month and accounts for the excess inflation above the Fed’s target, but it’s outdated. The two main components of shelter inflation both ticked up this month, dashing hopes that the long awaited drop in shelter inflation had arrived last month. Rent of primary residence increased from 0.3% MoM to 0.5% MoM and owner’s equivalent rent ticked up from 0.3% MoM to 0.4% MoM. Without shelter inflation, core inflation has actually been negative these past three months. Importantly, shelter inflation is a backward-looking metric that does not reflect current market conditions and inflationary pressure because it lags market rents by perhaps a couple of years or more. Redfin’s rental market tracker has shown that rents have essentially been flat for two years. That means that looking forward, there is little reason to expect shelter inflation to be problematic in the foreseeable future and waiting for inflation to come to the Fed’s target is simply a matter of waiting for the technicalities of how inflation is calculated to work itself out. Looking past these quirks, inflation is back at target, or very close to it.
From the Fed’s perspective, the balance of risk is shifting from high inflation to high unemployment. Today’s data means the Fed has permission to start cutting rates, but the next reading on the labor market will dictate how quickly they need to cut. The August 2 jobs report was a warning that the labor market is in danger of falling into a recession. With inflation largely under control and interest rates at a highly restrictive level, the Fed now has plenty of room to cut rates to keep a recession at bay. They have been very quiet since the last jobs report, but we will hear from Fed Chair Jerome Powell in Jackson Hole, WY next Friday. They won’t be making policy decisions, but will shed some light on their plans for the upcoming Fed meetings. And there is reason to be sanguine about the last jobs report as there might have been subtle Hurricane Beryl effects and much of the weakness seemed to stem from sluggish hiring (that could be temporary), rather than layoffs. The next labor market data point will go a long way to clarifying the trend. If the unemployment rate stays at 4.3% or higher, the Fed is likely to go for a 50 bps cut on September 18.
Mortgage rates have dropped considerably the last couple of months. Whether they continue sliding depends on whether the Fed is as aggressive as markets hope in cutting. Futures markets have priced in about 100 bps of cuts by the end of 2024 and about 200 bps of cuts by the end of 2025. That is significantly more than the Fed’s last projection in June, which included 25 bps of cuts by the end of 2024 and 125 bps of cuts by the end of 2025. Those projections are outdated now and all eyes will be on Chair Powell in Jackson Hole next Friday and on the next set of projections coming out of the September 18 Fed meeting.
