Economists say core CPI tells a more encouraging story for mortgage borrowers
May’s consumer price index (CPI) reading came in hot, with the headline inflation figure climbing by 4.2% over the past 12 months according to the Bureau of Labor Statistics and hitting its highest annual reading for nearly three years.
But while that might sound alarming – and normally, could raise the odds of Federal Reserve interest rate hikes – leading economists say the overall figure alone doesn’t necessarily tell the full story.
Rather than a sign that prices are running out of control, First American Financial’s deputy chief economist Odeta Kushi described the latest reading as “a tale of two CPIs,” containing both good and bad news.
“Higher energy costs pushed headline inflation to its fastest pace in two years, but underlying inflation remained relatively contained,” she wrote. “That’s likely enough to keep the Fed on hold, while leaving mortgage rate relief frustratingly out of reach for new buyers.”
Sal Guatieri (pictured below), director and senior economist at Bank of Montreal (BMO) Capital Markets, also told Mortgage Professional America the focus should be on underlying trends rather than the partly misleading top-line figure.
“It’s not so much the level, but the direction of inflation,” Guatieri said on the most important takeaways from the data. “Core measures of inflation have actually been falling and they’re tracking pretty close to the 2% target. So there’s no urgent need to move on interest rates.”
Core and headline inflation figures tell different stories
Core inflation strips out food and energy prices, the latter of which have been on a wild ride since the outbreak of the war in Iran at the end of February. Oil prices have surged during that period, unsurprisingly putting upward pressure on the headline rate.
That core figure jumped by 2.9% year over year in May – still almost a full percentage point above the Fed’s 2% target, but well below the overall consumer price index.
Core measures of US inflation “appear to be stabilizing,” Guatieri said, both on a three-month and monthly basis.
The Iran war stoked fears that geopolitical disruptions including oil supply snarls could feed through into broader price pressures. But to date, Guatieri said that doesn’t seem to have materialized.
“There does not appear to be clear evidence of a pass-through of higher energy costs or even other supply disruptions emanating from the Iran conflict to broader US inflation,” he said.
What it means for Fed rate decisions
While financial markets have upped their expectations for Fed rate hikes because of the inflation conundrum facing the central bank, Kushi reiterated that the encouraging core reading appears to push back against the most hawkish scenarios.
“The softer-than-expected monthly core reading also reduces the likelihood that policymakers will need to consider rate hikes,” she said. “The result is likely to reinforce the Fed’s current wait-and-see approach and keep rate cuts on hold for now.”
The central bank is due to make its next decision next week (June 17), the first time it will meet under new chair Kevin Warsh.
Meanwhile, the picture isn’t necessarily bleak for brokers and their clients, Kushi said, even if rates are showing no sign of a big drop anytime soon.
“Mortgage rates are driven more by inflation expectations and bond market conditions than by the federal funds rate itself, and today’s report offers little reason to expect a significant decline in borrowing costs in the near term,” she said.
May’s increase in existing-home sales, their strongest monthly gain of the year according to the National Association of Realtors (NAR), was another positive sign for the housing market’s prospects, according to Kushi.
“The encouraging news for housing is that demand appears to be waiting on the sidelines, rather than disappearing altogether,” she said.
“If inventory levels continue to improve and affordability gradually recovers, stronger confidence in the labor market and broader economy could help bring some of that pent-up demand back into the market, even if meaningful mortgage-rate relief remains elusive.”
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