Finally Good News on Inflation!

This morning’s Consumer Price Index (CPI) report finally gave the mortgage market something to celebrate.

Going into this morning’s report, the Headline rate of inflation was running at 8.2%. The market was anticipating a reduction to 8%. However, Headline inflation cooled down to 7.7% – awesome news for the stock and bond market.

Since the Fed watches the inflation rate that strips out both food and energy prices, the Core rate is truly the one to watch. Core inflation fell from a rate of 6.6% to 6.3%.

With the Fed targeting Core inflation at 2%, we are moving in the right direction but still have a way to go.

The annual rate of inflation is computed by taking the most recent 12 months of increases and adding them together. Therefore, to see the Headline rate fall, we must see the monthly pace of inflation trend lower. We did get that in today’s report, with October trending at a .3% pace.

If this rate were to remain, we would see a Headline rate of 3.6% per year in 12 months. Given that Fed rate hikes take up to six months to work their way through the economy, we are hopeful that this downward trend will continue as the impact of the past four Fed hikes of ¾% takes hold.

Shelter costs make up 39% of the CPI report. This component rose by .8% in October, which is the largest monthly increase in the history of the index.

As we are all aware, the rise in mortgage rates has softened home prices. This is now starting to trickle down to rent rates, so we should see downward pressure on the cost of shelter which will further drive down the CPI in the months to come.

Investors are now taking the thought of a ¾% Fed rate hike off the table. At this point, we can expect to see a maximum hike of ½%, with the idea of only a ¼% hike becoming more likely. Further, this could help lower expectations for the peak Fed Funds rate. If we see the labor market show signs of weakening, the Fed “Pause” could happen as early as February’s Fed meeting.

Mortgage interest rates have improved by 1/2% so far this morning. Given the pace of improvement, float only if you are closely monitoring the bond market. Be prepared to lock should the market pull back some of its gains.