Inflation is back in a big way
Inflation hit 6.8% in November, its highest level since the long-ago era of Reaganomics and the American inflation war. If prices keep rising, so will mortgage rates. But for borrowers too, there is a silver lining on the horizon of this cloud.
Today’s combination of low mortgage rates and high inflation is extremely rare. So either of these conditions is likely to end soon – and if prices stay high, economists say, mortgage rates will go up.
“Inflation tends to drive up mortgage rates, so I assume that we will start the new year with higher rates than at the end of 2021,” says Ralph McLaughlin, chief economist at Haus.com.
Last week’s inflation rate of 6.8% was its highest level in 39 years and there is little relief in sight. Consumer prices are likely to continue to rise, says Frank Nothaft, chief economist at the real estate data company CoreLogic.
And that means that mortgage rates are almost certain to go up. “We will see sustained upward pressure on interest rates,” says Nothaft.
When annual inflation topped 4% in the spring and 5% this summer, the Federal Reserve described the phenomenon as “transitory.”
Central bankers’ early analysis went something like this: The global economy hit the brakes in March 2020. Consumers stopped eating out, traveling and other typical spending patterns, creating a period of deflation. At the same time, the federal government replenished consumers’ bank accounts with economic money, thus preparing the conditions for a price increase as soon as the lockdown in the pandemic subsided.
When economic activity returned to normal, it was thought, prices would inevitably skyrocket. After all, annual inflation is only a comparison with prices a year ago. And consumers are spending a lot more this year than they were a year ago. But once consumers wore themselves out, the passing argument went that everything would go back to normal.
However, this is not the case. Shortages remain in all types of goods, including cars, appliances, and building materials. The Fed no longer calls inflation temporary.
In Necessity, CoreLogic sees inflation as a threat to historically low mortgage rates and sees signs that inflation will stay with us for a while. Yes, it is possible that supply chain problems will finally subside and slow price growth for cars, lumber and other items. But these goods are only part of the inflation index. The federal measure of consumer prices also includes housing and health care – and none of these elements will have prices falling when auto production returns to normal and port security ends.
“That makes it very, very difficult to bring inflation back to the Fed’s 2% target,” says Nothaft.
The unusual combination of high inflation and low mortgage rates makes borrowing more attractive right now. Because if long-term interest rates do not rise with rising prices, the “real” costs of repaying today’s mortgage will decrease over time.
Put simply, inflation is generally good news for borrowers, especially those with mortgages. You can repay the loan in increasingly cheaper dollars, which lowers the cost of borrowing.
The inflation picture is important to mortgage rates because it could force the Fed. Should inflation continue to rise, the Fed would have to raise interest rates in 2022. In fact, on Wednesday it forecast three rate hikes over the next year.
The central bank does not control mortgage rates, which are closely tied to 10-year Treasury bills. While the Fed’s decisions don’t affect mortgage rates as directly as other products like savings accounts and CD rates, the Fed’s actions indirectly affect the interest rates consumers pay on their fixed-rate home loans.
“Mortgage rates move based on long-term bond yields,” said Greg McBride, senior financial analyst at Bankrate. “If investors believe inflation will settle down and is not a longer-term problem, it will result in a more subdued mortgage rate response, despite the ugly inflation numbers we are seeing right now.”
In other words, an increase in mortgage rates is not a sure thing. However, the rise in consumer prices certainly makes a rate hike more likely.
“The surge in inflation is causing the Fed to change course, no longer calling it temporary, and likely doubling the rate of its slowdown at this week’s meeting,” said McBride. “Inflation is a problem in the short term, but if the Fed acts to contain it it will not be a problem in the longer term and it will not necessarily lead to an increase in mortgage rates. But the Fed’s credibility is key – and its credibility has suffered recently. “
A real estate sign is seen outside a home for sale in West Los Angeles on November 19, 2020. Two years and a pandemic later, mortgage rates could soon be rising.