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A surprising jump in a key inflation gauge means 2024 rate cuts that Federal Reserve policymakers telegraphed in December are more likely to happen later rather than sooner, which could keep mortgage rates from declining further until after the spring homebuying season.
The Bureau of Labor Statistics reported Thursday that rising rents and energy costs helped push the Consumer Price Index (CPI) up 3.4 percent in December from a year ago, compared to 3.1 percent annual growth in November.
It was the first time the key inflation index has moved in the wrong direction — away from the Fed’s goal of 2 percent — since September. Core CPI, which excludes volatile food and energy prices, was up 3.9 percent in December from a year ago, an improvement from 4.0 percent annual growth in November.
Diane Swonk
“Today’s data confirms our view that the Fed will cut much less aggressively than many in financial markets hope,” KPMG Chief Economist Diane Swonk said in a thread on the social media platform X. “They are seeking a soft landing. That is a tough needle to thread. Soft landings are not the same as no landing scenarios.”
Swonk said KPMG is holding to the firm’s previous forecast that the Fed will approve four rate cuts this year and that it won’t start bringing rates down until June.
Economists polled by Reuters before the latest inflation data was released also expected 10-year Treasury yields to stay about where they are until June, which would mean mortgage rates would probably remain little changed through the spring homebuying season.
Consumer price index
The CPI hit 9 percent in June 2022, after pandemic-fueled supply chain issues and Fed easing sent prices for food, gasoline and other goods soaring. To slow the economy, Fed policymakers raised interest rates 11 times between March 2022 and July 2023, bringing the federal funds rate to a 22-year high of between 5.25 percent to 5.50 percent.
The interest rate hikes — along with “quantitative tightening,” in which the Fed is expected to pull $1 trillion in support from bond markets this year — helped bring the CPI down to 3 percent in June. But inflation has proven stubborn, and further gains have been elusive.
However, futures markets tracked by the CME FedWatch tool show investors on Thursday afternoon were still pricing in a 69 percent chance that the Fed will start cutting rates in March, up from 43 percent on Dec 11. Futures markets are pricing better than even odds that the Fed will make six or more rate cuts in 2024, or twice as many as Fed policymakers indicated in their most recent summary of economic projections.
That’s also the thinking at Pantheon Macroeconomics, which is forecasting that 10-year Treasury yields, a barometer for mortgage rates, will fall from 4 percent to 3.5 percent by the end of June and to 3.25 percent by the end of the year.
Ian Shepherdson
“These numbers don’t change the big picture,” Pantheon Chief Economist Ian Shepherdson said in a note to clients Thursday. “Core goods prices are flat or falling, rent gains are slowing but remain elevated, and core services inflation is still sticky. Note, though, that the Fed cares more about the core PCE than the core CPI, and the two numbers often diverge month-to-month.”
PCE and Core PCE trending down
The Bureau of Economic Analysis reported on Dec. 22 that the Fed’s preferred inflation measure, the personal consumption expenditures (PCE) price index, dipped to 2.6 percent in November, down from 2.9 percent in October.
Core PCE, which can be a more reliable indicator of underlying inflation trends because it excludes food and energy prices, also dipped to 3.2 percent in November. With the exception of January, core PCE trended in the right direction every month last year.
“Wait for the core PCE before rushing to inflation judgment,” Shepherdson said of the numbers for December, which are set to be released Jan. 26.
While economists at Fannie Mae and the Mortgage Bankers Association still expect the U.S. will experience a mild recession in 2024, hopes are growing that the Fed will be able to achieve a soft landing. Even a soft landing will cause some pain, Swonk warned.
“In a soft landing, profit margins, especially among mid and smaller firms which are more exposed to rate hikes and the repricing of debt, are squeezed,” Swonk said. “Higher interest rates and the push back to price hikes prompts cost cutting and a scaling back of hiring plans.”
The silver lining is that the Fed now appears to be just as concerned about the risks of keeping rates elevated as it does about inflation.
At the Fed’s last meeting, “Powell made clear he was willing to avert a full-blown recession in 2024 given the progress made on cooling inflation,” Swonk said. “That is a major shift from where we were a year ago.”
Editor’s note: This story has been updated to correct that the personal consumption expenditures (PCE) price index is the Federal Reserve’s preferred inflation gauge.
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