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Federal Reserve policymakers are expected to start bringing interest rates down next week for the first time in four years after a key inflation gauge confirmed the economy continued to cool in August. But the Fed is likely to proceed cautiously as prices for some essentials — including housing — still appear to be rising at a faster clip than it would like.
After falling for five consecutive months to 2.53 percent annual growth in August, the Consumer Price Index is back to levels not seen since February 2021. The cost of oil and other energy was down 4 percent from a year ago, while food prices were up by only 2.1 percent, the Bureau of Labor Statistics reported Wednesday.
But a surprisingly large increase in core CPI, which excludes volatile food and energy prices, means that Fed policymakers are likely to start out with a modest 25 basis-point rate cut when they meet next week. A basis point is one-hundredth of a percentage point.
A string of weak jobs reports had sparked speculation that the Fed might kick off its rate-cutting campaign with a 50 basis-point reduction in the federal funds rate, or half a percentage point. But after the release of the CPI report, futures markets tracked by the CME FedWatch tool put the odds of a 50 basis-point rate cut on Sept. 18 at only 15 percent, down from 44 percent last week.
Chen Zhao
“A touch-hotter-than-anticipated August CPI report nudges the Fed toward a 25 basis-point rate cut at its meeting next week,” Redfin economist Chen Zhao said in a blog post. “However, inflation remains cool enough that the Fed could still surprise with a 50 basis-point cut to get ahead of further weakness in the labor market or simply project the possibility of larger cuts down the road.”
The Fed is still expected to approve equal or bigger rate cuts in November and December, with futures markets pricing in an 81 percent chance that the central bank will bring the federal funds rate down at least a full percentage point by the end of the year.
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 percent and 5.5 percent — the highest level since 2001.
The Fed will shed more light on its intentions next week when it updates the “dot plot” in its Summary of Economic Projections, which shows how each member of the Federal Open Market Committee thinks rates might have to be adjusted in the months ahead.
CPI trending down
Core CPI was up 3.26 percent from a year ago, driven by rising costs for shelter, airline fares, auto insurance, education, and apparel.
Pantheon Macroeconomics Chief Economist Ian Shepherdson said the increase in core CPI was largely driven by laggy rent data and “sampling noise” in calculating housing costs (“owners’ equivalent rent”).
Shepherdson expects core CPI inflation to ease to 2 percent during the first half of 2025.
Ian Shepherdson
“Looking ahead, every measure of pipeline price pressures still is giving a clear benign steer on the inflation outlook,” Shepherdson said in a note to clients. “Oil prices have tumbled over the last two months, while global food prices have largely flatlined. Supply chains remain frictionless and shipping costs have begun to come back down. Gross margins remain flat, while new rent increases, as captured by Zillow, are small and steady.”
The Federal Reserve’s preferred measure of inflation, the personal consumption expenditures (PCE) price index, also registered 2.5 percent annual growth in July — just half a percentage point above the Fed’s 2 percent target.
The PCE price index is derived from the CPI report and another monthly report, the Producer Price Index, which comes out on Thursday. The PCE price index for August is scheduled for release on Sept. 27.
Mortgage rates back to February 2023 levels
Mortgage rates continued to descend toward 6 percent this week as bond market investors who fund most home loans adjust to expectations that the Fed will gradually bring rates down this year and next.
Joel Kan
“Mortgage rates declined for the sixth consecutive week, with the 30-year fixed rate decreasing to 6.29 percent, the lowest rate since February 2023,” Mortgage Bankers Association Deputy Chief Economist Joel Kan said, in a statement. “Treasury yields have been responding to data showing a picture of cooling inflation, a slowing job market, and the anticipated first rate cut from the Federal Reserve later this month.”
Rate-lock data tracked by Optimal Blue, which lags by a day, shows rates on 30-year fixed-rate conforming mortgages have come down by a full percentage point from their 2024 high of 7.27 percent on April 25, hitting a new low for the year of 6.16 percent on Tuesday.
Homebuyers seeking FHA loans were securing rates at an average of 5.96 percent, according to a survey conducted by Mortgage News Daily. The survey also revealed that rates on 30-year fixed-rate loans had decreased by 11 basis points on Wednesday. Despite the drop in rates, potential buyers have been slow to respond due to limited listings and high prices in many markets.
However, there was a 2 percent increase in applications for purchase mortgages last week compared to the previous week, with overall application volume down only 3 percent from a year ago, as reported by the Mortgage Bankers Association’s Weekly Applications Survey. The Chief Economist at the MBA, Kan, noted that purchase applications are approaching levels from the previous year, but challenges such as affordability and limited inventory may still be impacting purchase decisions.
On the other hand, refinance applications have more than doubled compared to a year ago, with a 1 percent increase in refinance requests last week and a staggering 106 percent increase from the previous year. Lenders have slightly relaxed their underwriting standards in response to the surge in refinancing activity, as shown by the Mortgage Credit Availability Index (MCAI) from the MBA.
The MCAI, which tracks credit availability based on data from ICE Mortgage Technology, rose by 0.9 percent in August to 99. The index for conventional mortgages reached its highest level since July 2022, driven by an increase in cash-out refinancing and non-QM lending. Kan stated that the rise in credit availability was a result of lenders expanding their refinance offerings to meet the growing demand.
Overall, the mortgage market is experiencing a shift with decreasing rates, increased refinance activity, and a slight loosening of underwriting standards by lenders. These developments are expected to have a significant impact on both homebuyers and homeowners looking to refinance in the current market.