Downside Inflation Surprise

While the election results had little impact on mortgage markets this week, the CPI report on Thursday caused an enormous reaction. It revealed that inflation was lower than expected, and mortgage rates declined substantially.

Helping the figures come in below the expected levels, used car prices dropped 2.4% in October. Apparel and medical care services also posted steep monthly declines. Shelter (housing) costs, which account for roughly one-third of the CPI index, continued to post significant gains in October, but this component generally operates with a lag. Current indicators of shelter costs such as newly signed rental agreements suggest that this area will provide downward pressure on overall inflation readings in coming months. 

Inflation remains far above the readings around 2.0% seen early in 2021, which is the stated target level of the Fed. To help reduce inflationary pressures and reach this goal, the Fed will continue to raise the federal funds rate at future meetings. However, the magnitude of additional rate hikes anticipated by investors dropped sharply due to the CPI data. For example, investors were nearly evenly split before the report between a 50 and a 75 basis point increase at the next meeting in December and now widely expect just 50 basis points. 

Investors will be hoping for more specific Fed guidance on the pace of future rate hikes and bond portfolio reduction. Retail Sales will be released on Wednesday. Since consumer spending accounts for over two-thirds of U.S. economic activity, the retail sales data is a key measure of the health of the economy. Import Prices also will come out on Wednesday. Housing Starts will be released on Thursday and Existing Home Sales on Friday.