Yesterday’s Panic Subsides After CPI

PPI spooked markets, CPI calmed them, here’s what both reports mean for next week’s Fed decision and where mortgage rates go from here. These are always important reports, but once or twice a year they draw an extra level of attention, this is one of those times, thanks to the Federal Reserve’s rate decision coming next week.

So what is the data that was released?

The Producer Price Index came in slightly higher than expected yesterday, 5.4% year-over-year, a 0.4% increase from last month and the market sold off more than it probably should have. Selling off means investors sold mortgage-backed securities and Treasuries on fears that yields would move higher, which is exactly what happens when investors sell. Mortgage rates ticked up yesterday amid the “panic,” but we’re seeing some leveling off today.

The CPI report, released this morning, came in line with expectations at 3.4% year-over-year and a 0.4% increase from last month. These numbers make sense given the big drop in oil prices back in July, which fed into July’s data, followed by a slight increase in August so a bit of a correction was natural.

What’s affected by these reports?

With the Fed meeting next week and a rate decision coming Wednesday, these reports all but rule out a cut and the odds of a rate increase just went up. Chairman Warsh has been direct about where the Fed’s focus is right now: with the jobs numbers stable, they’re squarely focused on inflation.

A major piece of that inflation picture right now is the Iran conflict. Oil prices have been on a roller coaster over the last six months, and energy prices work their way into the cost of nearly everything we buy. The Fed has no control over global oil supply, but it does have the ability to affect the U.S. money supply, which directly affects inflation.

What’s the thought process?

As we’ve discussed in other posts, the federal funds rate is the rate at which banks lend to each other or borrow from the Federal Reserve. When banks borrow from the Fed, it effectively pulls dollars out of circulation. Fewer dollars in circulation should reduce inflation. So if the Fed’s goal right now is lower inflation, the odds of a rate hike to fight it have gone up with these latest reports.

Purely from a mortgage-rate perspective, a Fed rate hike is actually a good thing for us. Mortgage rates lag behind and follow inflation trends so if the Fed is raising the funds rate to bring inflation down, mortgage rates should follow suit if the plan works. It’s a seemingly inverse relationship, and if you want a deeper dive into why, check out our article, “Why a Fed Rate Cut Doesn’t Lower Your Mortgage Rate.”