How low can mortgage rates go with cooler inflation?

With the labor market showing signs of softening and the Federal Reserve expressing concerns, the possibility of our first-rate cut in 2024 looms. However, despite strides in managing inflation since 2022, the 10-year yield remains above 4%. The Fed’s steadfast caution has prevented any significant shift in its stance, leaving the decision in its hands. Yet, today’s outcome is a victory, and we await the Producer Price Index (PPI) inflation report tomorrow.

From BLS: The Consumer Price Index for All Urban Consumers (CPI-U) declined 0.1 percent on a seasonally adjusted basis, after being unchanged in May, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 3.0 percent before seasonal adjustment.

As depicted in the chart below, we are steadily progressing in managing inflation. The CPI inflation, which includes a significant 45% contribution from shelter inflation, has been a critical factor in this progress today. However, the shelter index, which tends to lag, has been slow over the last six months before this report today. This has frustrated some Fed members who anticipated today’s number to show up earlier in the year, so they must be very pleased today.

This month’s report shows the slowest month-to-month growth in rent in long time — precisely what the Fed doctor ordered.

Tomorrow, we have the PPI inflation report, which is critical because the components of the PPI inflation report filter into the PCE inflation data, which the Fed prefers as its primary inflation metric. They want the PCE inflation data to get toward 2%. We have to remember that shelter isn’t as impactful on the PCE inflation data, but the PCE inflation data has been having 2% handles on the 12-month data for some time now.

How low can mortgage rates go?

We’ll know more after we see the PPI inflation report tomorrow. However, as often noted, we have made significant progress on inflation with no Fed rate cuts and the 10-year yield is still above 4%. It’s critical to break the stubborn level of 4.20% on the 10-year yield if we want to see mortgage rates drop closer to 6.5%.

However, one silver lining this year that isn’t being discussed much is that the spread between the 30-year mortgage and the 10-year yield is improving. This is a good sign and something we discuss on our weekly tracker articles. If the spreads return to normal, mortgage rates would be near 6% or lower today with the 10-year yield. We will address this issue and others in the next HousingWire Daily podcast.

For now, let’s keep our eye on the prize, which is labor data. Jobless claims did come in better today. By now, we all know that the Fed is putting more weight on labor data over inflation. If inflation had driven their full mindset, we would have had cuts already. However, as they have stated, they have kept rates high because the labor market has allowed them to.

Today, let’s call it a victory as the 10-year yield has dropped and is testing that critical 4.20% level. We will see how the PPI inflation data looks tomorrow. However, today’s data should make the Fed feel better because the lagging shelter inflation data is becoming a reality. We have a lot to work with in the second half of 2024, but we are making progress in fighting inflation.

Let’s hope the Fed proves me wrong and does pivot before a job loss recession happens. Either way, making progress on inflation and the labor data getting softer is a more positive trend for mortgage rates in the future.

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