Dramatic inflation reading fuels speculation that Federal Reserve policymakers will implement drastic 75-basis point interest rate hike Wednesday.

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Mortgage rates surged above 6 percent Monday, amid a sell off in bond markets prompted by worries that worsening inflation will prompt the Federal Reserve to implement a drastic rate hike when policymakers meet Wednesday.

A Labor Department report, released Friday, reveals inflation hit 8.6 percent in May — the highest reading in more than 40 years — raising the prospect that the Fed will implement a 75-basis point increase in the short-term federal funds rate either this month or next.

The Fed approved the first short-term interest rate hike since 2018 in March, raising the federal funds rate by 25 basis points, or one-quarter of a percentage point. That move was followed by a more dramatic 50-basis point hike on May 4, the biggest short-term interest rate hike in 20 years.

Friday’s inflation report sent long-term interest rates including mortgages higher, and that trend accelerated Monday as investors dumped bonds in what Reuters characterized as a “huge sell off.” When investors sell bonds, their value decreases. And because there’s an inverse relationship between bond prices and yields, when prices drop, yields go up.

The sell off hit two-year Treasurys harder than 10-year bonds, producing an inverted yield curve. An inverted yield curve — particularly when yields on two-year Treasurys exceed those for 10-year bonds — is often a warning sign of a recession.

Ten-year Treasury yields continue to climb

Yields on 10-year Treasurys, a useful signal of where mortgage rates could be headed next, climbed 20 basis points Monday, to levels not seen since 2011.

Another report released Monday, the New York Federal Reserve’s Survey of Consumer Expectations, shows median inflation expectations increased to 6.6 percent in May, tying a record set in March in records dating to 2013.

Mortgage rates rebounding

The Optimal Blue Mortgage Market Indices show rates on 30-year fixed-rate have been in a steady upward trend since May 27. At 5.661 percent on Friday, rates on 30-year fixed-rate loans were up 39 basis points in the last two weeks, surpassing the previous 2022 peak of 5.593 percent seen on May 6.

A rate index compiled by Mortgage News Daily shows rates for 30-year fixed-rate mortgages surged 28 basis points on Monday, to 6.13 percent.

Mortgage rates could quickly level off or even ease, depending on what action and commentary the Fed provides at its meeting Wednesday.

The CME FedWatch Tool, which monitors futures contracts to calculate the probability of Fed rate hikes, shows bond traders are now pricing in a 55 percent probability that the Fed will implement a 75 basis point rate hike by July 27, with a 26 percent chance they’ll make such a move this week.

But Thomas Costerg, senior economist at Pictet Wealth Management, told Reuters that he’s skeptical that the Fed will take such a drastic step.
“Over the summer, they will be aware of growth data and housing which is starting to look more wobbly,” Costerg told Reuters. “I doubt they will do 75 [basis points] … 50 [basis points] is already a big step for them.”

Pantheon Macroeconomics Chief Economist Ian Shepherdson, sounded a similar note in a message to clients Friday, saying wage gains are likely to moderate, and that by September, “the housing meltdown will have everyone’s attention, and [even] continuing to hike by 50 (basis points) will look gratuitous.”

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