Stuck in Place
Checking in on Inflation Expectations & the Mortgage Rate
On the heels of the most recent inflation report, anticipation for another Fed rate-cut next month has waned. As of today there is only a 2.5 percent expectation of a cut at next month’s meeting (according to Fed Funds futures prices).1
What could change the Fed’s mind between now and the next meeting of the FOMC on March 19th? Well, for starters, inflation needs to come down.
To see where inflation is headed, let’s read some “tea leaves.” By that Macrosight means let’s check-in on two related barometers of future inflation: inflation expectations and the 30-year mortgage rate (discussed together this past October by Macrosight).2
Current Expectations
Figure 1 displays the 30-year mortgage rate and one-year inflation expectations (what market participants believe inflation will be one year from now).3 The timeline displayed is from February 2024 through February 2025.
Some things to notice:
Since Macrosight last looked at inflation expectations and the mortgage rate together, inflation expectations have crept up each month—from 2.3 percent in October to 2.7 percent as of this month. This uptick comes after a steady decline from May to September.
Since October, the Fed has reduced its interest rate target twice, by a total of 50 basis points (after the initial 50 basis point cut in September).
The 30-year mortgage rate has also crept up since October (after that relatively big jump between September and October). While the rate dropped a hair from January to February, as far as this housing market-metric is concerned we are essentially in the same place we were a year ago.
Where does this leave us?
It seems with inflation and with the 30-year mortgage rate we are more or less stuck in place. While inflation expectations revealed some optimism over the summer months of 2024, we are now about where we were last spring, hovering around 2.7 percent expected inflation.
Perhaps though, we should consider ourselves lucky that inflation expectations are only 2.7 percent and the mortgage rate is not any higher than it is. The CPI rate of inflation has average 3.0 percent since last February (through January of this year).4 And, the CPI rate of inflation read 3.4 percent in November, 4.4 percent in December, and 5.6 percent just last month! That sequence does not portend good-tidings.
In their January meeting, the Fed did not change the Federal Funds rate target (currently at 4.25-4.5 percent). That lack of action also helps explains the Futures market prediction. Macrosight explained the Fed Fund Futures market here.
Why do we look at inflation expectations and the mortgage rate together? As explained in that October post, “Long-term interest rates like the 30-year mortgage rate include an “inflation premium.” That means if lenders think inflation is going to increase, they increase the offered 30-year rate by some amount. If inflation is low and stable, and lenders expect inflation to continue to be low and stable, that inflation premium should be smaller than otherwise. Hence, if the inflation premium is lower, the 30-year mortgage rate should be lower, all else equal.”
In last October’s post, Macrosight also plotted inflation expectations for two-year, five-year and ten-year horizons. Here, Macrosight made the executive decision that looking at the one-year was good enough for this cold winter day (and there was not much additional insight from the additional horizons).
Referring to the CPI for all items (CPI-U), discussed in last week’s post.