Economic Commentary for January 23rd, 2014 : Rates Improve on Low Inflation

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There were few surprises in the economic data released over the past week. The labor market, manufacturing and housing data indicated that economic growth continues at a moderate pace. This, combined with tame inflation data, resulted in a small improvement in mortgage rates.

The Fed’s decision on December 18 to begin to taper its bond purchase program has reduced that uncertainty for the market. Investors now are focused more closely on the economic fundamentals. The primary factor setting the level of mortgage rates is the expected amount of future inflation. Since inflation erodes the value of future payments, investors demand a higher yield when inflation is expected to rise.

This week, two of the primary monthly inflation reports showed that inflation remains low. The Core Consumer Price Index (CPI), which looks at the price change for finished goods which are sold to consumers, was just 1.7% higher than one year ago. As can be seen from the chart, Core CPI has been holding steady near current levels since April. The story is similar for the Producer Price Index (PPI), which focuses on the increase in prices of “intermediate” goods used by companies to produce finished products. Core PPI was 1.5% higher than one year ago. Given the moderate pace of economic growth and the slack in the labor market, investors and Fed officials see little risk that inflation will increase significantly any time soon.

The next Fed meeting will take place on January 29. Investors will be looking for information about the expected pace of reductions in the bond purchase program. Fourth quarter Gross Domestic Product (GDP), the broadest measure of economic growth, will be released on January 30. The home sales data also will be closely watched next week. The next Employment Report will come out on February 7.

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