Inflation and Mortgage Rates

  • There is no consumer price inflation to speak of – as of yet.  Even the expectation of future inflation rates remains low.  This is the key reason as to why mortgage rates remain at historically low rates and why the cost-of-living-adjustment (COLA) for social security checks will barely rise next year.
  • The latest consumer price inflation in September was up only 1.7 percent.  This particular month is the basis for the COLA for many checks issued by the government for the year 2015.
  • Because of the falling gasoline prices in the past month, there could be further deceleration in inflation in the upcoming months.  But energy prices are always subject to volatile swings.  If energy prices measurably turn up due to unanticipated geopolitical events, then the overall inflation rate could be pushed above the Federal Reserve’s desired 2 percent ideal inflation target.
  • Another factor that could move higher and hence push up the overall inflation rate is from the housing sector.  Rents rose 3.3 percent over the 12 months to September, the highest pace in nearly 6 years.  Homeowner equivalency rents, a hypothetical number of what homeowners would receive if they were to rent out their home, are also hitting near 6-year high.  Given insufficient new home construction in relation to population and job growths, both rent components are further poised to rise.  Given that the housing is the biggest weight to the CPI calculation, the overall CPI could easily kick into high gear.
  • Though there has been massive printing of money by the U.S. Federal Reserve in the past few years (to buy government bonds and mortgage backed securities – something known as Quantitative Easing), inflation so far has been very tame.  Should inflation at some point pop out, however, then all the borrowing costs including mortgage rates will rise to compensate for the future loss in purchasing power.  The likelihood of inflation popping out to 10 percent or higher as happened during the large money printing period of the 1970s is highly unlikely.  But a higher inflation of 3 to 4 percent within a year is a distinct possibility.  In such a case mortgage rates will commensurately get pushed up.
  • The Federal Reserve has many contingency plans in place to assure that recent printing of the money does not lead to high inflation.  Just for an interesting historical anecdote and not as a possibility, even a remote one, it is worth recalling the years after the discovery of America by Christopher Columbus.  Spain experienced a long period of high inflation.  The monetary system at that time was based on precious metals of gold and silver.  The large shipments of gold and silver from the New World to the Old World resulted in too much metal-based money chasing after too few goods (since many Spaniards stopped working to live the easy life).  The result was too much inflation and Spain defaulted on sovereign debt several times.  As one historian puts it: “The new world conquered by Spain, has now conquered Spain in return.”   Common sense says that the greatness of a country is determined by how hard people work and not by how easy it is to obtain currency.

If you like what you see and think this post would be of interest to someone, please share