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Mortgage rates are trending down again this week with the release of two economic reports showing inflation continues to ease, convincing investors who fund most home loans that the Federal Reserve will start cutting rates on Sept. 18.
The big question following Wednesday’s release of the latest Consumer Price Index (CPI) report and Tuesday’s Producer Price Index (PPI) data is how drastically the Fed will cut rates at three remaining meetings this year.
While Fed policymakers are expected to dip their toe in the water by making a modest, 25-basis point rate cut next month, many investors and economists had speculated that recent job market weakness might justify a larger, 50-basis point cut in September.
A basis point is one-hundredth of a percentage point, so a 50-basis point cut would bring the short-term federal funds rate down by half a percentage point, to between 4.75 and 5.0 percent.
This week’s CPI and PPI reports suggest that while inflation is moving in the right direction, fears of a recession may have been overblown.
Futures markets tracked by the CME FedWatch Tool on Wednesday put the odds of a 50-basis point cut in September at just 35 percent, down from 53 percent Tuesday and 69 percent on Aug. 7.
Diane Swonk
“The combination of margin compression in the pipeline revealed in the producer price index for July and today’s CPI underscores the Fed’s pivot from worrying about inflation to the labor market and underscores the argument for cuts to begin in September,” KPMG U.S. Chief Economist Diane Swonk posted on X.
Margin compression “is fine unless it triggers layoffs,” Swonk said. “We don’t have a lot of room to absorb layoffs and the length people are taking to find a new job has increased.”
The deceleration and declines in prices seen in recent inflation data are more broad-based than they were a year ago, Swonk said, and the slower pace of hiring in late June means that further slowdowns in hiring or a pickup in layoffs will push unemployment higher.
“Those shifts and the fact that the Fed discussed a rate cut in July, reinforces the argument for a half percent cut in September to ensure we avoid a full-blown recession,” Swonk said. “The risk is not insignificant and it is time. Rate cuts thereafter will be calibrated to the incoming data.”
Economists at Pantheon Macroeconomics expect the Fed to cut rates by 1.25 percentage points this year and that the federal funds rate will be below 3 percent by this time next year.
Rates on 10-year Treasurys, a barometer for mortgage rates, dropped four basis points Tuesday following the release of PPI data, but only half that much on Wednesday’s CPI report. Lender surveys by Mortgage News Daily showed rates on 30-year fixed-rate loans coming down three basis points Tuesday and by the same amount Wednesday.
Mortgage rates back to May 2023 levels
Mortgage rates have been dropping steadily since late April on rising expectations for Fed rate cuts. But the release of two startlingly weak jobs reports at the beginning of August accelerated the decline, as investors piled into mortgage-backed securities (MBS) as a hedge against a possible recession.
After hitting a new 2024 low of 6.4 percent on Aug. 5, rates on 30-year fixed-rate conforming mortgages bounced back to 6.54 percent last week, as bond market investors ruled out an emergency Fed rate cut and pondered whether fears of a recession were overblown.
Rates are on the retreat again on this week’s inflation reports, with 30-year fixed-rate conforming mortgages averaging 6.45 percent Tuesday, according to rate lock data tracked by Optimal Blue.
That’s an 82-basis point drop from a 2024 high of 7.27 percent registered on April 25, bringing rates on the popular purchase loan back to May 2023 levels.
But most of the decline in rates didn’t take place until after the end of the spring homebuying season. So far, the big drop in rates in August has mostly spurred refinancing.
Applications to refinance jumped 35 percent last week compared to the week before and were up 118 percent from a year ago, according to a weekly lender survey by the Mortgage Bankers Association.
Purchase loan applications rose by a seasonally adjusted 2 percent from the week before, and were down 8 percent from the same time a year ago.
Joel Kan
It was the strongest week for refi applications since May 2022, MBA Deputy Chief Economist Joel Kan said in a statement, while the small pickup in purchase loan demand indicates “that prospective homebuyers are slowly reentering the market.”
Applications to refinance accounted for 49 percent of all mortgage requests last week, compared to 30 percent during the week ending April 26, when rates were at 2024 peaks.
But there’s plenty more inflation data coming before the Fed’s September meeting that could keep mortgage rates coming down.
CPI at lowest level since March 2021
After falling for four consecutive months to 2.9 percent annual growth in July, the Consumer Price Index is back to levels not seen since March 2021.
The index for shelter rose 0.4 percent from June to July, accounting for nearly 90 percent of the 0.2 percent monthly increase in the all-items index, the Bureau of Labor Statistics reported.
Core CPI, which excludes volatile food and energy prices, has also been moving in the right direction since April, falling to 3.2 percent in July.
The Producer Price Index for final demand increased 2.2 percent for the 12 months ended in July, according to the Bureau of Labor Statistics.
The Federal Reserve’s preferred measure of inflation, the personal consumption expenditures (PCE) price index, dropped to 2.5 percent in June from a year ago — just half a percentage above the Fed’s 2 percent target.
The PCE price index for July, which is derived from the CPI and PPI reports, is scheduled to be released on Aug. 30.
Ian Shepherdson
Pantheon Macroeconomics Chief Economist Ian Shepherdson said Tuesday’s PPI numbers and Wednesday’s CPI data imply that inflation is cooling more quickly than the Fed had forecast in June, and “PCE data won’t stand in the way of a 50-basis point cut [in September] if August payrolls are as lackluster as July’s.”
Forecasters at Pantheon predict core CPI will fall to 2.7 percent by December and average 2 percent in 2025.
“The labor market is slackening quickly, dragging down wage growth and new rent increases, while PPI data highlight substantial scope for retailers to respond to slowing growth in consumers’ spending by reducing their margins,” Shepherdson said in a note to clients Wednesday.
Federal funds rate at 23-year high
To encourage borrowing and keep the economy from crashing during the pandemic, the Fed dropped the federal funds rate — the rate banks charge each other for overnight loans — to 0 to 0.25 percent in 2020.
In their efforts to tame inflation, Fed policymakers approved 11 increases in the federal funds rate from March 2022 through June 2023, bringing the target for the short-term rate to between 5.25 and 5.5 percent — the highest level since 2001.
While the Federal Reserve doesn’t have direct control over mortgage rates, bond market investors in government debt and mortgage-backed securities (MBS) adjust their appetites for such investments based on their expectations for economic growth and future Fed moves. Fears that the economy will slow or crash increases demand for such investments, driving their prices up and yields down.
For months, investors have assumed that the Fed would ease into rate cuts with an initial 25-basis point reduction. On July 12, futures markets tracked by the CME FedWatch Tool put the odds of a 25-basis point cut in September at 90 percent.
But by Aug. 7, the release of surprisingly weak July jobs numbers had investors pricing in a 69 percent chance of a 50-basis point rate cut in September.
While a 25-basis point cut in September is now seen as more likely, economists at Pantheon Macroeconomics are forecasting that Fed policymakers will also make 50-basis point cuts in November and December, which would bring the federal funds rate down by 1.25 percentage points to a target range of 4.0 to 4.25 percent.
Futures markets tracked by the CME FedWatch Tool on Wednesday were predicting only a 36 percent chance that the Fed will cut that hard and that fast, down from 41 percent Tuesday.
By this time next year, Pantheon Macroeconomics forecasts that Fed policymakers will have brought their target range for the federal funds rate down to between 2.5 and 2.75 percent, while futures markets see 3.25 to 3.5 percent as the most likely level.
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