MarketTrends 12/13/2024: Fed Math: 3.3% = 4.5%

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But it's the core rate of inflation -- a measure that does not include food or energy -- that's more germane for the Fed's purposes. Core CPI rose by another 0.3%, the fourth consecutive month with a gain of that size, and this kept the annual rate of core CPI inflation at a steady 3.3% for a third consecutive month. The report did show that prices for services were steady on a monthly basis and still easing on an annual basis, while goods prices are firming again. As recently as three months ago, annualized goods inflation was declining at a 1.9% rate; now, it's just -0.6%. At the moment, is appears that the mix of price pressures may be changing, but all higher costs must be paid in the end.

Now, it's fair to say the core CPI isn't the same as core PCE, and that's true, given different weightings and such. That said, and at least through October, core PCE had edged up to a 2.8% annual rate from 2.7%, reaching its highest point since April. The Fed is trying to achieve 2% core PCE inflation, but in the most recent measure, inflation is still running about 38% above target. Even leaving out the differences between core CPI and core PCE, it's hard to see how an inflation rate of 3.3% would find the Fed feeling compelled to cut the federal funds rate another quarter point, to 4.5%.

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It would be one thing if the Fed was looking to support a weakening or fragile economy; however, the last two quarters have featured GDP growth running at about 2.9% rate on average, and the GDPNow model from the Federal Reserve Bank of Atlanta pegs the fourth quarter of 2023 at a 3.3% growth rate through December 9. It would be another thing if the Fed was looking to revive a moribund labor market, but that's really not the case, either. It is true that job openings have declined, hiring has downshifted, the unemployment rate remains above recent bottoms and that it's taking longer for those who have lost positions to find new ones; however, not all that long ago, these were the very conditions the Fed was trying to foment, and in general, the labor-market metrics are all pretty solid.

It's not only prices at the consumer level that are stubborn. The Producer Price Index (a measure of inflation roughly upstream of the consumer, if not directly) is also firming up again of late. In November, the top-line figure for PPI showed a 0.4% increase for the month, the highest since June. Prices for goods paid by producers rose by 0.7% and services by 0.2%. "Core goods" (no food or energy costs) rose by 0.2%, the same as was the case in five of the last six months. With the bump in costs, overall PPI is running at a 3% annual rate, back to where it was in June and fairly abrupt change in direction from the flat 2% annual rate seen as recently as August. Of the components, annualized service costs ticked higher (3.9%, highest since February 2023), overall goods moved up to a 1.1% annual pace and core goods 2.2% was essentially level, with the 2.2% rate seen in three of the last four months.

Prices for goods coming into the U.S. and goods and services leaving it have also begun to edge higher, reducing or eliminating an important source of deflation. Prices for imported goods rose a meager 0.1% in November, but it was a second such rise; on a annual basis, import prices are increasing at 1.3% rate. While that is not much, it is a trend in the wrong direction, and just two months ago, the same annualized import costs were declining. Costs of exports were unchanged in November (after posting a stout 1% increase in October), but the annual rate for export inflation remained at +0.8%. Like import costs, export prices were recently declining (-1.8% in September) but the trend has reversed a bit of late.

It appears there's also a little divergence of opinion about what the latest inflation data actually mean. During the week, and despite the inflation data, futures markets investors strengthened their bets on a Fed cut; a week ago, that probability was about 86%, and so there seems to be a general expression of lessened concern about inflation. Conversely, bond buyers seem to hold a different opinion of the incoming data; bonds mostly sold off all week long, and the influential yield on the 10-year Treasury rose from about 4.14% early Monday morning to just about 4.41% by Friday afternoon. This reflects somewhat greater concern regarding price pressures, and as such, it looks like we'll be seeing mortgage rates pushing higher even as the Fed is cutting short-term policy rates.

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Fed Chair Powell has mentioned recently that the Fed no longer sees labor market conditions as an important driver of inflation, now that things have become more balanced. Improved worker productivity is likely not far from the core of that line of thinking, as improving output per hour means that more goods and services can be made available without putting additional strains on the pool of labor, and that workers can be paid more, too. In the revised report covering the third quarter of 2024, worker productivity expanded by a healthy 2.2% clip, allowing per-unit costs of labor to increase only 0.8%. At least over the last six quarters, output per worker has been running above the average increase in output over the last 10 years (1.8%), and the recent trend is probably a source of comfort for the Fed.

There was an upward flare in initial claims for unemployment assistance in the week ending December 7. An increase of 17,000 requests compared to the week prior left them at 242,000, the loftiest level of the last two months, although not outside of a recent range, and not yet a reason for concern. Seasonal adjustments this time of year often distort things a bit, but the increase bears watching to see if it is repeated in the coming weeks. Continuing claims for benefits rose a little last week as well, and remain neat a three-year high.

Goods stockpiles at the nation's wholesaling firms expanded by 0.2% in October. These intermediaries between factories and retailers expanded their holdings of durable goods by 0.1% and non-durable goods by 0.3%. Inventories increased as sales sagged a bit, falling by 0.1% for the month, and a retreat from September's half-point increase. The increase in stocks failed to change the overall inventory-to-sales ratio for either durable or non-durable goods, and overall remained at 1.34 months of supply at the present pace for sales. This may be low enough as to prompt a few more orders to manufacturers, who would likely welcome any increase in them.

Mortgage rates may not be all that low, but there are still folks responding to them. For the week ending December 6, the Mortgage Bankers Association reported a 5.4% increase in the number of applications for mortgages. While requests for purchase-money loans tailed off by 4.1% and broke a four-week string of gains, those for refinancing leapt higher by 27.2%, largely on the strength of refinancing of VA and FHA-backed loans. Not coincidentally, both of those programs offer forms of lower-cost streamline refinancing, so borrowers can grab a new, lower interest rate without having to come up with much (or any) cash. Unless mortgage rates continue to decline, it's unlikely that the increase in refinancing can be sustained.

We're not exactly certain how the totality of the data suggests that a cut in rates by the Fed is warranted, or how 3.3% core CPI inflation translates into the central bank lowering the federal funds rate to 4.5%. Still, that's the likely outcome of the Fed meeting next week. We still think the decision to make the move will be a close one, but that level of detail regarding the decision won't be available until the minutes of the meeting come out next year. We'll of course have our usual post-meeting analysis of the Fed's actions on Wednesday afternoon, and will be keen to see if the messaging from Fed Chair Powell and the updated Summary of Economic Projections changes the outlook for policy relative to what it was in September. It should be interesting and instructive.

Looking into next week, it appears that the recent slide for mortgage rates will end. Based on how influential yields moved this week, we think that the average offered rate for a conforming 30-year fixed-rate mortgage as reported by Freddie Mac will increase by about 16 basis points or so, erasing most (and potentially all) of the decline seen over the last few weeks. Whether they retreat again to close out 2024 will depend on what the Fed has to say, and what the PCE price data for November shows.

There's a lot going on as 2024 starts to wind to a close, including elections and consequential Fed decisions. What will happen to mortgage rates between now and mid-December? See what we think in our latest Two-Month Forecast for mortgage rates.

To start each year, we release our Annual Mortgage and Housing Market Outlook. In it, we take a forward look at a range of topics, including mortgage rates, Fed policy, home sales, home prices and lots more. We recently did a mid-year review to see how well market conditions met our expectations. Have a look and see how things are turning out.

For a really long-run outlook, you'll want to check out "Federal Reserve Policy and Mortgage Rate Cycles".

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