The Fed’s Cooling of Services: Implications for the Labor Market and Home-Based Mortgage Rates in the Coming Phase of Inflation
The cost of services such as travel and restaurant meals continues to put pressure on people’s pocketbooks despite a cooling of inflation due to falling gasoline prices.
The consumer price index for the month of March was 5% higher than it was a year ago. That’s the smallest annual increase since May 2021.
While inflation is still more than two-and- a-half times the Federal Reserve’s target, it has continued to ease since hitting a four-decade high last summer.
The collapse of two big regional banks last month complicated the Fed’s efforts to curb inflation.
That acts like an additional brake on the economy, amplifying the Fed’s own rate hikes. Fed policymakers will have to weigh the uncertain effects of those tighter credit conditions in deciding how much higher interest rates need to go.
The Fed’s job is to be very paranoid. “They pay us what they want us to do,” said Austan Goolsbee, president of the Chicago Federal Reserve Bank. It means we have to dig into new information in more exciting times like the time we’re in right now.
Goolsbee told the Economic Club of Chicago that the services sector, which wasn’t immune to the disease, still hasn’t adjusted to a rapid rebound in demand and is the most worrisome price hike today.
Goolsbee said that the economy is coming back after a long time. Goods inflation has come down. “But now services inflation, especially in the categories where spending is discretionary and was repressed for a few years — like travel, hotels, restaurants, leisure, recreation, entertainment — demand has returned and the inflation has proved particularly persistent.”
Housing and manufacturing are sensitive to rising interest rates, but the service industries are not.
One encouraging sign for the Fed is that wages — an important factor in service prices — have cooled in recent months. Average wages in March were 4.2% higher than a year ago, compared to a 4.6% annual increase in February.
The 30-year fixed-rate mortgage averaged 6.27% in the week ending April 13, down slightly from 6.28% the week before, according to data from Freddie Mac released Thursday. A year ago, the 30-year fixed-rate was 5%.
With the economy seeing progress on inflation and mortgage rates still under 4%, this should help keep mortgage rates at a lower end of the range that we have seen in recent months. “However, any surprises in the data will likely lead to some volatility in that range.”
The average rate dropped lower this week as bond yields bounced back from last week’s lows following economic data including last Friday’s jobs report that signaled a moderating, but still relatively strong job market, said Danielle Hale, Realtor.com chief economist.
“On the other hand, overall inflation slowed more notably, and even core inflation on a month-to-month basis eased somewhat, a sign that the Fed’s tightening is having the desired effect,” she added. If the Fed needs to raise rates a bit, we are close to the end of the tightening cycle.
The Fed doesn’t set interest rates that borrowers pay, but it does what it can to influence them. Mortgage rates tend to track the yield on 10-year US Treasury bonds, which move based on a combination of anticipation about the Fed’s actions, what the Fed actually does and investors’ reactions. When Treasury yields rise, so do mortgage rates. When mortgage rates fall, so do mortgage rates.
There was an improvement in sentiment toward housing before the recent easing in mortgage rates.
Despite the huge shifts in market momentum, home sellers can still rely on the seasonal trends tipping the scales a bit more in their favor and Home shoppers should expect a fair amount of competition that should ease as we move later into the year,” she said.