OK… that may be a bit of an exaggeration, but it is true that inflation has utterly dominated the outlook for rates. The Consumer Price Index (CPI) is the first of major inflation reports on any given month and by far the most widely followed by financial markets. In other words, the traders that indirectly determine changes in mortgage rates are waiting on the edge of their seats for each month’s CPI data and their reactions have frequently been extreme.
This week’s reaction qualifies. It was simply amazing (in a bad way) when considered against the extent to which the results diverged from expectations.
To simplify, consider that the most important line item in the report operates on a scale of tenths of a percent. It was expected to come in at 0.3 but instead came in a 0.4. Moreover, that 0.4 was rounded up from 0.359%–almost low enough to round down to 0.3!
If you’d told us that ahead of time, we would have assumed bond market weakness (i.e. higher rates), but nothing on the scale of what we actually saw. The 5 day chart of 10yr Treasury Yields (a benchmark for longer term rates like mortgages) tells the story.
Mortgage rates were just as upset. The 30yr fixed rate index jumped nearly 0.30%, putting Wednesday in line with one of only a handful of days with a spike of 0.25% or more over the past 20 years.
A chart of the index itself is slightly less troubling considering it’s still well below last year’s highs, but the gap is much smaller after this week.
Why did we see such a big reaction for such a small deviation in the data? Simply put, the market keeps waiting for a trend toward lower inflation to resume and the data keeps breaking hearts. This week’s report was sort of a “third times the charm” moment. Jan and Feb CPI (released in Feb and Mar, respectively) were also surprisingly high. They did damage to rates to be sure, but markets and even officials from the Federal Reserve were hoping those reports were outliers.
The following chart shows month over month core CPI (the one that came in at 0.4 instead of 0.3). The Fed (and the market) is waiting for that line to get back into the target zone. Unfortunately, it looks like it took one look at the target zone and said “no thanks!”
The Fed continues to remind the market that inflation progress is a bumpy road and that these recent setbacks aren’t necessarily evidence of defeat. After all, the year over year trend still looks OK despite leveling off a bit from its previous trajectory.
The big question is what it takes for progress to resume. The Fed’s answer is “just a bit more time.” They are still talking about cutting rates in 2024, but not as early in the year as initially expected. Wall Street is mixed in its expectations, with firms expecting anywhere from 0 to 3 cuts.
As is always the case, no one can be sure what the future will bring when it comes to economic data and the market reaction. All we can know at present is the progress toward lower rates in 2024 that was widely predicted in late 2023 is unequivocally on hold. A handful of other economic reports can make for fine tuning adjustments in the meantime, but bigger picture progress will depend on progress in the inflation data. There are a few exceptions that could bring rates down even before inflation condones it, but they’re all arguably worse than the waiting (war, recession, and other disasters).
