Prospects for lower mortgage rates grow as inflation continues to ease

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Mortgage rates look like they have room to keep dropping in July after a closely-watched gauge of inflation showed the economy continued to cool in May.

The personal consumption expenditures (PCE) price index, the Federal Reserve’s preferred gauge of inflation, fell to 2.56 percent in May from a year ago, the Commerce Department’s Bureau of Economic Analysis reported Friday.

It was the second-consecutive month that annual inflation inched closer to the Fed’s 2 percent target, raising the odds that the central bank will start bringing short-term interest rates down as soon as September.


Core PCE, which excludes the cost of food and energy and can be a more reliable indicator of underlying inflation trends, dropped to 2.57 percent in May — the lowest reading since March 2021. The Core PCE index hasn’t moved away from the Fed’s 2 percent target since January 2023.

Ian Shepherdson

Ian Shepherdson

“Looking ahead, we see little chance of a lasting and broad-based re-acceleration in the core PCE deflator after the slowing in April and May,” Pantheon Macroeconomics Chief Economist Ian Shepherdson said in a note to clients. “Accumulating labor market slack is increasingly weighing on wage growth, commodity prices are broadly flat, supply chains remain fluid, margins are under increasing pressure, and newly-agreed rents are rising slowly.”

While Pantheon economists expect core PCE to pick up slightly from May to June, after that they’re looking for “a multi-month run” of decelerating inflation.

“If we’re right, the Fed should be confident enough by its meeting in September that core PCE inflation is heading sustainably back to 2 percent that it can start to ease,” Shepherdson said.

Futures markets tracked by the CME FedWatch tool on Friday put the odds of at least one Fed rate cut in September at 64 percent, up from 46 percent on May 28.

PCE and Core PCE trending down

After peaking at 7.12 percent in June 2022, a series of Fed rate hikes gradually tamed inflation to 2.48 percent in January. But the PCE price index showed inflation worsening in February and March, sending mortgage rates rebounding as hopes for multiple Fed rate cuts in 2024 dimmed.

The latest declines in PCE and core PCE were in line with expectations, as previous data releases that the indexes build on — including the Consumer Price Index (CPI) and Producer Price Index (PPI) — also suggested that inflation eased in May.

Bond market investors who fund most mortgages initially snapped up 10-year Treasury notes after the PCE numbers for May were released at 8:30 a.m. EDT Friday, pushing yields as low as 4.26 percent. But 10-year Treasury yields, a barometer for mortgage rates, quickly climbed back above Thursday’s close of 4.29 percent.

Daily loan lock data tracked by Optimal Blue, which lags by a day, showed rates for 30-year fixed-rate mortgages averaging 6.88 percent Thursday, down 39 basis points from a 2024 high of 7.27 percent registered April 25. A basis point is one-hundredth of a percentage point.

An index maintained by Mortgage News Daily (MND) showed rates for 30-year fixed-rate loans climbed 2 basis points Friday, to 7.07 percent. Rates reported by MND are higher because they are adjusted to estimate the effective rate borrowers would be offered even if they’re not paying points. Optimal Blue tracks contracted rates, including those locked in by borrowers who pay points to get a lower rate.

Mortgage rates are largely determined by investor demand for mortgage-backed securities, and investors are skittish about the prospects that the Fed will continue its “higher for longer” rate strategy. Fed policymakers indicated at their June 12 meeting that they’ll be cautious about bringing rates down until they’re certain that inflation won’t surge again.

Speaking to bankers at a conference Thursday, Federal Reserve Governor Michelle Bowman attributed much of last year’s progress on inflation to “easing of supply chain constraints, increases in the number of available workers due in part to immigration, and lower energy prices.”

Michelle Bowman e1634247409370

Michelle Bowman

Bowman called it “unlikely” that those factors will contribute to bringing inflation down more in the future. Supply chains “have largely normalized, the labor force participation rate has leveled off in recent months below pre-pandemic levels, and an open U.S. immigration policy over the past few years, which added millions of new immigrants in the U.S., may become more restrictive.”

Additional “upside risks” that inflation will worsen include potential spillovers from regional conflicts that might disrupt global supply chains and send food, energy, and commodity prices soaring.

“There is also the risk that the loosening in financial conditions since late last year, reflecting considerable gains in equity valuations, and additional fiscal stimulus could add momentum to demand, stalling any further progress or even causing inflation to reaccelerate,” Bowman said.

Bowman, rated by Reuters as the most hawkish Fed policymaker for her hardline stance against inflation, reiterated that she’s willing to raise rates if needed — a position she’d previously staked out in October and May.

“While the current stance of monetary policy appears to be at a restrictive level, I remain willing to raise the target range for the federal funds rate at a future meeting should the incoming data indicate that progress on inflation has stalled or reversed,” Bowman said Thursday.

Mortgage rates expected to keep falling

FNMA MBA mortgae rate forecasts 6.24.24

Source: Fannie Mae Housing Forecast, June 2024; MBA Mortgage Finance Forecast, June 2024.

But the recent decline in mortgage rates from 2024 highs has revived interest among homebuyers, and housing industry economists think rates have more room to come down this year and next.

Homebuyer demand for purchase loans picked up for the third-consecutive week during the week ending June 21 after mortgage rates hit their lowest levels in months, according to a weekly survey of lenders by the Mortgage Bankers Association (MBA).

In a June 24 forecast, MBA economists said they expect rates on 30-year fixed-rate loans to drop to 6.6 percent during the fourth quarter of 2024, and to an average of 6.0 percent during Q4 2025.

Fannie Mae economists said on June 10 that they envision 30-year fixed-rate loans will drop to 6.7 percent during Q4 2024, and to 6.3 percent by the end of next year.

More listings and lower mortgage rates should boost 2025 home sales by 9.3 percent, to 5.3 million transactions, Fannie Mae forecasters said.

But analysts at Bank of America Global Research think home sales might not rebound until 2026 if home prices continue to rise and inventory continues to be constrained by the “lock-in effect” experienced by homeowners who refinanced when rates were at historic lows.

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