Price Plateau
January 31, 2025 -- The Federal Reserve held a policy-setting meeting this week, ultimately deciding to take no action and leaving the federal funds rate unchanged. There was little new insight into the Fed's thinking in either the statement that closed the meeting or in Chairman Powell's post-meeting press conference.
In his prepared remarks, Mr. Powell noted "significant progress" made toward the Fed's two goals of full employment and price stability over the last two years, while acknowledging that inflation "remains somewhat elevated." While it is true that progress has been made toward those goals, it is also true that there really hasn't been much progress made in some time. Given pandemic distortion, it's difficult to compare the labor market two years ago to today; certainly, millions more people are on payrolls. However, the unemployment rate of late is currently higher than those days, too, running at 4.1% now as compared to 3.5% then.
The improvement in inflation is easier to see; two years ago, headline PCE prices were running at a 5% annual rate, and core PCE at 4.4%, and steadily declining. Currently, those figures are 2.6% and 2.8%, and firming or firm. Annualized PCE inflation has risen by a half percentage point since September, so there's certainly no progress at all to be seen here. As well, annualized core PCE has held at the present level for the past three months, and is little better than it was last April, so there is no recent evidence of progress in getting inflation down to target levels. Given this, it's reasonable to think that the rate cut in December (and perhaps November as well) were perhaps less than optimally timed.
"Longer-term inflation expectations appear to remain well anchored," noted the Chair, but at least by those inferred from consumer surveys, that's somewhat less the case now than months ago. As we noted in the January 24 MarketTrends, the University of Michigan survey showed that the "one-year outlook for prices moved up to 3.3% in January to its highest level since May., while the five-year outlook for inflation moved back up to 3.2%, matching the high-water mark for a monthly series that began ten years ago." The Conference Board's Consumer Confidence survey's inflation gauge in January moved up to 5.3%, back to where it was last July.
Still, the Fed feels it is in a good place. "I think our policy stance is very well calibrated [...] to balance the achievement of our two goals," said Chair Powell. With this as a backdrop, folks hoping that the Fed will quickly return to cutting rates are likely to be disappointed for at least some time. In an answer provided during his press conference, he noted that "we're going to be focusing on seeing real progress on inflation or alternatively, some weakness in the labor market before we, before we consider making [policy] adjustments." and later said that "it comes down to 12-month inflation because that takes out the seasonality issues that may exist."
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Given the trend for prices of late, there has been no real progress on inflation for months, and given the apparent discounting of monthly fluctuations (better or worse) it may take many months to see "real progress" on inflation before the Fed will again consider cutting rates. Absent a deterioration in labor conditions or the economy, that's probably six months or more.
The December monthly Personal Consumption Expenditure (PCE) price report was out this week. As noted above, the Fed is looking beyond monthly fluctuations, which is good, since overall PCE rose by 0.3% in December, its largest monthly increase since last May. Goods prices continued in a firming trend which recently emerged, rising by 0.2%; services costs pushed 0.3% higher, about the average monthly increase seen routinely for many months now. Core PCE ticked 0.2% higher in December after just a 0.1% lift in November, and as described above, annual PCE is 2.6% at the headline and 2.8% at the core, with neither headed especially in the right direction.
Economic growth was slower in the fourth quarter of 2024, but still solid. The preliminary review of GDP growth for the period pegged growth at a 2.25% annualized rate, down from 3.07% in the third quarter. It is safe to assume that the twin hurricanes last fall that devastated the southeast damped this figure to some degree, but how much isn't certain. Regardless, for all of 2024, GDP growth managed a solid 2.5% rate, and in the final quarter of the year consumer spending contributed at its fastest pace since the first quarter of 2021, although this strength was offset by drag elsewhere. For the period, PCE rose by 2.3%, up from 1.5% in the third quarter, with core PCE at 2.5%, up from 2% -- more signs of progress in reverse on inflation recently.
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Perhaps the best measure of the costs of keeping an employee on the books, the Employment Cost Index is a measure that tracks both wages and benefit costs, and is among the indicators the Fed follows to track changes in labor conditions. The ECI for the fourth quarter of 2024 came in at 0.9%, up a tenth of a percentage point compared to the prior quarter but in line with both expectations and a longer easing trend. The report noted that wages increased by 0.9% for the quarter, up a tick, while benefits costs remained at 0.8%. On an annual basis, these changes put the ECI at 3.8%, down a tenth percent, and part of a long cooling process that began after a 5.1% peak two years ago. While lower labor costs have been beneficial in helping inflation to settle over the last couple of years, present levels remain a full percentage point or more above where they were in the period leading up to the pandemic, so there is still room for improvement.
Personal incomes rose by 0.4% in December, lifted by a 0.4% increase in wages, but also bolstered by gains in other income streams. Wages have expanded by either 0.4% or 0.5% in each of the last six months, so continue to run at a pace a little above one that might help inflation to retreat more easily, but wages expanding at a pace above inflation is allowing "real" incomes to continue to catch up after inflation eroded buying power. Other contributions to this month's headline increase include a 0.5% lift in proprietor's incomes, a 0.6% rise in income from rental properties and a 0.2% bump from returns on investments. Even direct government support payments added to the tally, contributing 0.2%.
The boost in income was more than outstripped by a surge in personal spending, which rose by 0.7% for December. More outgo than income had the expected effect on savings, which dropped to a 3.8% rate to close 2024, the smallest addition to household savings in two years.
Sales of newly-constructed homes posted a 3.6% increase in December, landing at a 698.000 annual rate. This was a better showing than was expected, and November's initial estimate was revised higher by 10,000 units, too. The end-of-year improvement came despite high mortgage rates, as consumers seem to be drawn in by ample inventory of homes available to buy and builder incentives such as price reductions and financing support. The supply of new homes at the present rate of sales edged down to 8.5 months; the actual (annualized) number of units ready to be sold was 494,000, the highest figure since December 2007, some 18 years ago and just before the financial crisis and Great Recession fully upended the housing market.
That's not to say the housing market isn't still upended in some ways; it is, but for different reasons now, like record high existing home prices and generationally-high mortgage rates. Both those items (plus the effect of holidays) damped the number of home purchase contracts signed in December. The trio of conditions resulted in the Pending Home Sales Index from the National Association of Realtors record a 5.5% decline to close 2024, its first retreat since July. Since it can take 30-60 days for a signed contract to turn into a sale, we'd expect to see the impact of the decline in PHSI reflected mostly in February's sales figures. Reckoning off the 4.24 million pace for December, this would see existing home sales drop back to about the 4.00 million level by then.
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Consumers were less cheery in January. The Conference Board's measure of Consumer Confidence retreated again to start the year, shedding 5.4 points and landing at 104.1, a four-month low. Present conditions were assessed to be considerably less favorable, as a 9.7-point drop in this component saw it sag to 134.3, returning to a level last seen in September-October. The outlook didn't change all that much, as the expectations component eased by just 2.6 points to 83.9, but this was also enough to return it to end-of-last-summer levels. Purchasing plans for autos and homes sagged and inflation expectations rose to a six-month high.
There's a full slate of labor-related data coming out next week, and we'll certainly learn a lot more about what's happening. What we do know is that few folks are requesting unemployment assistance. In the week ending January 25, just 207,000 new applications for benefits were filed, down 16,000 from the prior week. Continuing claims for ongoing support remain close to a three-year high, but also managed a little improvement, dropping 42,000 to 1.858 million to close January.
With mortgage rates high and fairly steady it's not likely we'll see any kind of sudden change in the number of folks applying for mortgages. The Mortgage Bankers Association reported that there was a 2% decline in the number of requests for mortgage credit in the week ending January 24. Applications for funds to purchase homes eased by 0.4% for the week, while those to refinance existing mortgages dropped 6.8%. To get much by way of improvement in demand for loans, we'll likely need to see mortgage rates drop back to perhaps 6.5% or so, if not lower.
Current Adjustable Rate Mortgage (ARM) Indexes
| Index | For The Week Ending | Year Ago | |
|---|---|---|---|
| Jan 24 | Dec 27 | Jan 26 | |
| 6-Mo. TCM | 4.27% | 4.30% | 5.21% |
| 1-Yr. TCM | 4.19% | 4.23% | 4.80% |
| 3-Yr. TCM | 4.34% | 4.36% | 4.15% |
| 10-Yr. TCM | 4.61% | 4.60% | 4.14% |
| Federal Cost of Funds |
3.719% | 3.767% | 3.855% |
| 30-day SOFR (daily value) | 4.34932% | 4.56011% | 5.34600% |
| Moving Treasury Average (MTA/12-MAT) |
4.686% | 4.747% | 5.081% |
| Freddie Mac 30-yr FRM |
6.96% | 6.91% | 6.63% |
| Historical ARM Index Data | |||
But this probably can't happen as long as inflation remains at the levels it currently holds, at least barring some significant deterioration in the economic climate somewhere (which would serve to help crush inflation further). If Fed policy is still "meaningfully restrictive", per Fed Chair Powell, inflation should subside further over time, and long-term interest rates and mortgage rates would find space to decline.
When that might come or at least start to be seen is anyone's guess at this point. A Fed on hold for an indefinite period, inflation that really stopped improving months ago and all manner of uncertainty in the outlook for fiscal, trade and regulatory policy aren't exactly the factors that promote lower rates in the near-term horizon.
A rough time in the equity market to start this week saw a fair rally in the bond market, driving down the influential on the 10-year Treasury. This appears likely to translate into a modest improvement in mortgage rates next week. As investors digest the usual first-week-of-the-month cascade of fresh economic data, we expect to see a 4 to 7 basis point decline in the average offered rate for a conforming 30-year fixed-rate mortgage as reported by Freddie Mac.
With the outlook changing for Fed policy and amid stubborn inflation, what's likely to happen with mortgage rates this winter? Why not check out our latest Two-Month Forecast for mortgage rates to see what we think.
See our new 2025 Mortgage and Housing Market Outlook, covering mortgage rates, housing conditions, the Fed and lots more.
Also, for a really long-run outlook, you'll want to review "Federal Reserve Policy and Mortgage Rate Cycles".
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