How Inflation Affects Mortgage Rates

INTRODUCTION

Inflation is a critical factor that influences the broader economy, including mortgage rates. As inflation rises, the purchasing power of money decreases. A persistant rising in prices during and after COVID due to tight supply chains and Covid-related shutdowns prompted the Federal Reserve to take action to curb inflation and stabilize the economy.  

RISE IN INTEREST RATES

In an effort to curb inflation, the Federal Reserve in March 2022 implemented its hawkish stance ever since the 1980s  raising it's Federal Funds rate a total of 11 times between March 2022 and July 2023 before leaving the rate unchanged for ninth of the last 10 meetings. At it's most recent meeting in July 30-31 the Federal Reserve announced that it would refrain on raising rates again while it waits for more economic indicators to guide its policies, leaving the federal funds rate at a target range of 5.25 to 5.5 percent. 

THE MEASURE OF INFLATION AND TRENDS

The Consumer Price Index (CPI) measures the change in prices paid by consumers for goods and services and is a key measure of inflation. The Index has been rising at a slower rate since the Federal Reserve implemented its Fed fund rate hikes in 2022. As of the latest data, CPI all items stands at 2.9% year-over-year. CPI for Shelter, a measure of changes in home prices remains at 5.03%, above it's pre-covid range. Markets are beginning to price in a potential drop in interest rates as inflation measures move towards Fed's target rate of 2% and economic indicators continue to indicate slowing economy with the hope of a soft landing, avoiding a recession.

The Federal Reserve does not directly set mortgage rates. However, by affecting the Fund Fed Rate, the rate by which banks lend to each other overnight, the Federal reserve influences short-term loans and credit lines. Mortgage rates tend to track the 10-year Treasury closely which makes it an important indicator to watch. The T-bond tends to reflects investor sentiment about future economic conditions and inflation expectations. Currently, the yield on the 10-year T-bill is around 4.6%. As this yield rises, mortgage rates typically follow suit.

As of now, the average 30-year fixed mortgage rate is hovering around 6.43%, down from approximately 7.9% in October 2023 but still higher than pre-pandemic rates. This decline in mortgage rates has be attributed to the Federal Reserve’s pause on raising rates as inflation began declining, the economy softening and buyer demand declining as affordability decreased over the years. Higher mortgage rates mean higher monthly payments for homebuyers, which could dampens demand in the real estate market.

In summary, rising inflation has prompted the Federal Reserve to adopt a more aggressive stance on interest rates, leading to higher mortgage rates in 2022 and 2023. As the For those in the real estate market, staying informed about these economic indicators—CPI and the 10-year T-bill—can help you make better decisions whether you’re buying or refinancing a home.

Keep an eye on these trends and consult with financial experts to navigate this challenging environment effectively.