The March inflation report came in hotter than expected, which means the Fed is highly unlikely to cut interest rates in June–and could mean the Fed only cuts rates once this year. The news is already pushing up mortgage rates.
Higher-than-expected inflation in March means that the Fed will almost certainly delay rate cuts until July or perhaps even September, and trim the number of cuts this year from 2 or 3 to 1 or 2. This will keep mortgage rates elevated for longer through the peak homebuying season.
Inflation was higher than expected across the board. Overall inflation came in at 0.4% month over month, the same as last month and higher than expectations of 0.3%. Relative to a year ago, prices were up 3.5%, more than last month’s 3.2% increase and expectations of 3.4%. Because energy and food prices are volatile, the Fed prefers to strip those out and look at “core inflation”. Core inflation rose 0.4% month over month (3.8% year over year), the same as last month, but higher than expectations of 0.3% (3.7% year over year).
Sticky shelter inflation continues to keep core inflation elevated. Shelter inflation makes up 40% of core CPI. Based on real time rent data, shelter inflation has been expected to decline for more than a year. And it has, but not to the extent market rent data would predict. It’s possible that compositional differences between CPI and market rent data explain these trends, but it’s also possible that CPI shelter inflation just needs more time to catch up.
A third month of high inflation casts doubt on the hypothesis that the elevated January and February readings were driven by special start-of-year effects. This is the third month in a row where core CPI has increased by 0.4% relative to the previous month. The Fed wants that number to be 0.2-0.3% to be consistent with their inflation targets. Economists figured the January and February readings were buoyed by one-off effects related to price jumps at the beginning of the year. However, those should have petered out by March, so a third reading at that level points to a stronger economy and labor market keeping inflation elevated.
The Fed is now highly likely to push any rate cuts back to July or September and pare back the number of cuts this year. While the Fed focuses on an alternative measure of inflation known as core PCE, and the difference between core CPI and core PCE is historically large right now, this CPI report still contains enough signal for core PCE that it will change the Fed’s trajectory. At the March 20 Fed meeting, officials were still narrowly predicting three rate cuts in 2024, with markets expecting the first to come in June. Coupled with last Friday’s stronger than expected jobs report, today’s data makes three rate cuts pretty unlikely. July looks like the earliest start of the cutting cycle, but it could be September if inflation remains sticky. However, the Fed might be reluctant to cut in the meetings right around the election, meaning there’s some possibility that we will only get one cut this year, in December.
Mortgage rates are likely to increase today and stay elevated for longer, perhaps through the peak spring and summer homebuying season. Ten-year treasury yields rose about 12 bps on the news, and daily average mortgage rates jumped to 7.29% from 7.06% yesterday. Mortgage spreads (the difference between 10 year treasury yields and mortgage rates) have come down in recent months from over 300 bps to about 270 bps meaning the sell off in bonds these past few months haven’t affected mortgage rates as much as they did last year. However, that trend appears to be reversing today with mortgage rates rising more than the 10 year yield. Today’s data and the implications for the Fed will almost certainly keep mortgage rates elevated in the near term. Absent new economic data that would allow the Fed to cut sooner, homebuyers and sellers may not see much–if any–relief through the traditional peak homebuying season.
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