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Mortgage rates gained room to come down again Friday after a key inflation metric improved in August, giving investors more confidence that the Federal Reserve will continue cutting rates aggresively in November.
The personal consumption expenditures (PCE) price index, the Federal Reserve’s preferred measure of inflation, showed the prices of goods and services rose by 2.2 percent in August from a year ago. That’s down from 2.5 percent in July, and shows inflation continues to inch closer to the Fed’s 2 percent goal.
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Yields on 10-year Treasurys, a barometer for mortgage rates, dropped by as much as 5 basis points Friday. Bond market investors are growing more convinced that Fed policymakers will follow up last week’s dramatic 50 basis-point reduction in short-term interest rates with an identical move on Nov. 7. A basis point is one-hundredth of a percentage point.
While Fed policymakers have made it clear they intend to continue bringing short-term rates down this year and next, uncertainty over the pace and timing of those cuts has tugged mortgage rates up and down.
Many economists had expected the Fed to start its rate cutting campaign last week with a more restrained 25 basis-point cut in the federal funds rate. But “the tepid inflation figures” released Friday “underscore why the Fed was so confident” to start out with a bolder move, KPMG U.S. Chief Economist Diane Swonk said in a bulletin.
The CME FedWatch tool, which tracks futures markets to calculate the probability of future Fed moves, on Friday put the odds of another 50 basis-point cut in November at 57 percent, up from 49 percent on Thursday.
Inflation nearing Fed’s 2 percent target
Friday’s release of the PCE price index showed that since hitting a post-pandemic peak of 7.25 percent in June 2022, the annual inflation rate has come down by a full 5 percentage points, to 2.24 percent.
Diane Swonk
“The improvement in inflation is broader based than we saw just a year ago with discounting putting downward pressure on many goods prices,” Swonk said. “Everything from the pushback by consumers on price hikes to increased productivity growth, the strong dollar and excess capacity abroad is keeping the pressure on prices.”
Core PCE, which excludes the cost of food and energy, peaked at 5.65 percent in February. Since dropping to a 2024 low of 2.63 percent in June, core PCE creeped up in July and August, to 2.68 percent.
Forecasters at Pantheon Macroeconomics said recent declines in energy prices and shipping costs lead them to believe that core PCE inflation will edge down to 2.5 percent in the final three months of 2024.
Since hitting a 2024 high of 7.27 percent on April 25, mortgage rates have been on the decline as bond market investors who fund most mortgages priced in expectations that the Fed would cut rates this year and next.
But when the central bank actually started cutting short-term rates last week, mortgage rates bounced back as investors digested the latest “dot plot,” which showed Fed policymakers envisioned a cautious pace for future cuts.
Mortgage rates on the rebound
After hitting a new 2024 low of 6.03 percent on Sept. 17, rate-lock data tracked by Optimal Blue shows rates on 30-year fixed-rate conforming mortgages have climbed by 10 basis points, averaging 6.13 percent Thursday.
Optimal Blue data lags by a day, but rate data tracked by Mortgage News Daily showed mortgage rates eased slightly Friday. Rates on 30-year fixed rate loans failed to match the decline in the 10-year Treasury yield, however, coming down by only a single basis point.
To fight inflation, the Fed raised the federal funds rate 11 times from March 2022 through June 2023, bringing its target for the short-term rate to between 5.25 percent and 5.5 percent — the highest level since 2001.
But in addition to keeping inflation in check, the Fed is tasked with using its monetary policy tools to help maintain full employment. Now that Fed policymakers are gaining confidence that they’ve got inflation in check, they’ve pivoted to cutting rates down to keep the economy from slowing down too rapidly and shedding jobs.
The latest dot plot showed policymakers envisioned bringing the federal funds rate down by a total of 2 percentage points this year and next, implying 25 basis-point cuts in November and December and several rate cuts totaling 1 percentage point in 2025.
But Pantheon forecasters think that if job growth continues to cool and unemployment keeps rising, the Fed will be forced to move more quickly to avert a recession. Pantheon is forecasting that by next June, the federal funds rate will be 2.75 percentage points lower than its recent peak.
Sub-6 mortgage rates forecast for spring
Source: Fannie Mae and Mortgage Bankers Association forecasts, September 2024.
Economists at Fannie Mae and the Mortgage Bankers Association forecast rates on 30-year fixed-rate loans will drop below 6 percent during the second quarter of 2025, in time for the spring homebuying season.
In a Sept. 23 forecast, MBA economists said they expect rates on 30-year fixed-rate mortgages will average 6.2 percent during the final three months of 2024, and drop to 5.8 percent in Q4 2025.
Fannie Mae economists in a Sept. 10 forecast projected that rates on 30-year mortgages will average 6.1 percent during Q3 2024, and 5.7 percent in Q4 2025.
Another data release Thursday showing the economy grew at an annual rate of 3 percent during the second quarter of 2024 put upward pressure on long-term interest rates.
But Thursday’s revised estimate of gross domestic product (GDP) also raised hopes that Fed easing will ward off a recession and help the economy achieve a “soft landing.”
“Consumer spending has picked up on the heels of discounting, which is the very definition of a soft landing,” Swonk said. “The tepid inflation figures underscore why the Fed was so confident that inflation was moving close to its target when it cut by half a percent in September. At least another half percent in cuts is expected by year-end. An unusually weak employment report for September could tip the scales in favor of larger cuts.”
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Email Matt Carter