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Federal Reserve policymakers are expected to begin cutting interest rates 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 with caution as prices of other key assets – including housing – still appear to be rising at a faster clip than we would like.
After falling for five consecutive months to 2.53 percent annual growth in August, the Consumer Price Index returned to levels not seen since February 2021. Oil and other energy costs were down 4 percent from last year, while food prices were up only 2.1 percent, said the Bureau of Labor Statistics on Wednesday.
But the surprisingly large increase in core CPI, which excludes volatile food and energy prices, means Fed policymakers are likely to start with a 25 basis point cut when they meet next week. A basis point is one hundredth of a percentage point.
A string of weak jobs reports has fueled speculation that the Fed may begin its rate-cutting campaign by cutting the federal funds rate by 50 basis points, 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 rate cut on September 18 at just 15 percent, down from 44 percent last week.
Chen Zhao
“A warmer-than-expected August CPI report is pushing 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 so cool that the Fed could still surprise with a 50-basis-point cut to preempt further weakness in the labor market or even hint at the possibility of more tapering down the road.”
The Fed is still expected to agree to equal or greater rate cuts in November and December, and futures markets are pricing in an 81 percent chance that the central bank will cut the federal funds rate by 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 to June 2023, bringing the short-term rate target to between 5.25 percent and 5.5 percent — the highest rate since 2001.
The Fed will shed more light on its intentions next week when it updates the “dot plot” in its Economic Projections summary, which shows where each member of the Federal Open Market Committee thinks rates may need to adjust in the coming months.
CPI is trending down
Core CPI increased 3.26 percent from a year ago, driven by rising costs of accommodation, airfare, car insurance, education and goods.
Pantheon Macroeconomics Chief Economist Ian Shepherdson said the increase in core CPI was largely due to weak rent data and “sampling noise” in calculating housing costs (“equivalent rent for owners”).
Shepherdson expects core CPI inflation to slow to 2 percent during the first half of 2025.
Ian Shepherdson
“Looking forward, all estimates of pipeline price pressures still provide clear guidance on the inflation outlook,” Shepherdson said in a note to clients. “The price of oil has dropped in the last two months, and the prices of food around the world have dropped significantly. Supply chains remain seamless and shipping costs have started to come down. Yields remain low, while new rent increases, as measured by Zillow, are small and steady.”
The Federal Reserve’s measure of inflation, the personal use expenditures (PCE) price index, also registered annual growth of 2.5 percent in July — just half a percentage point above the Fed’s 2 percent target.
The PCE price index is found in 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 September 27.
Loan rates return to February 2023 levels
Home mortgage rates continued to fall as much as 6 percent this week as bond market investors who fund many mortgages adjust to expectations that the Fed will gradually cut rates this year and next.
Joel Kan
“Mortgage rates fell for the sixth week in a row, and the 30-year fixed rate fell to 6.29 percent, the lowest rate since February 2023,” Mortgage Bankers Association Deputy Chief Economist Joel Kan said in a statement. “Treasury yields were responding to data that showed a picture of cooling inflation, a slowdown in the labor market, and the first rate cut at the Federal Reserve later this month.”
Lock-rate data tracked by Optimal Blue, back on the day, showed rates on the 30-year fixed-rate mortgage fell a full percentage point from the 2024 peak of 7.27 percent on April 25, a new low. changed to +6.16% compared to the previous trading day. Borrowers looking for FHA loans were locking rates at an average of 5.96 percent.
A survey of lenders by Mortgage News Daily revealed that rates for 30-year mortgages fell another 11 basis points on Wednesday.
With listings scarce and prices elevated in many markets, home buyers have been slow to respond to the drop in rates.
But mortgage applications rose a seasonally adjusted 2 percent last week compared to the previous week, and application volume was down just 3 percent from a year ago, according to the Mortgage Bankers Association’s Weekly Applications Survey.
“Purchase requests increased during the week and are approaching last year’s levels,” Kan said. “Despite falling prices, affordability challenges and other factors such as limited inventory are still likely to hamper purchasing decisions.”
Applications for refinancing are coming in at a rate more than double last year’s average, with applications for refinancing up 1 percent last week compared to the previous week and 106 percent from last year.
Lenders have loosened their underwriting standards somewhat in response to the new financing boom, according to MBA’s Mortgage Credit Availability Index (MCAI).
Mortgage lenders are getting a little lenient
Source: Mortgage Bankers Association
The MCAI, based on data from ICE Mortgage Technology and measured at 100 in March 2012, rose 0.9 percent in August, to 99.
The credit availability index for conventional loans reached its highest level since July 2022, driven by increased refinancing and non-QM lending.
“Mortgage rates have been declining since May 2024, prompting refinance activity, which remains limited to a small portion of high-income homeowners,” Kan said. “As a result, the increase in credit availability was the result of lenders expanding their financing offerings to meet the increased demand.”
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