Mortgage Rates and Inflation—A Dangerous Dynamic?

US home mortgage rates are at 20-year highs and rental rates still remain elevated. Is it possible that the future of inflation and Fed Fund interest rates are relying solely on these factors now?

Hi, I’m Liz Laprade Senior Research Analyst with Today’s Adviser Takeaway.

Housing comprises about 35% of the US consumer’s monthly expenditures. Housing also makes up about 30% of the Consumer Price Index, which measures inflation. So, home prices, mortgage rates and rental prices all have a huge impact on both the health of the consumer and inflation rates.

The health of the consumer drives economic growth, and inflation right now is driving the Fed’s decision on interest rates. And all of this drives the markets. So right now, the US home mortgage rate for 30-year fixed is at about 7%.

Compare that to a prior five-year average of about 4%, and in COVID it bottomed at 2.8%. So, it’s not surprising that more than half of all outstanding 30-year fixed rate mortgages were originated between 2020 and 2022. And not surprising that not nearly as many people are applying for mortgages right now.

An article on this was sent around the team yesterday and it was making the case that, since so many borrowers are locked in at lower rates, the Fed might have to raise interest rates for longer before these homeowners start to feel any real negative impact on their budgets. Basically, saying that they’re spending just as much as in lower rate environments today.

The higher mortgage rates have thus had a knock-on effect for rent because it’s converted potential homeowners to rentals. So, this has then pushed median rental rates much higher over the last few years. And rent has been what has remained consistently elevated in the inflation index.

So the question is, does the current mortgage and rent dynamic mean inflation will stay elevated and that the Fed will need to continue raising interest rates for longer?

I do think it’s possible that this dynamic has played a large part in keeping inflation elevated over the past year, whether we realize it or not. However, I do not think it will remain a consistent barrier looking forward this year.

We’re already starting to see the median rental price rate go down and we can’t forget that, although mortgage rates are higher and maybe some people aren’t paying those higher rates, our credit card rates, auto home loan rates, corporate lending rates, those are all very elevated and we have to pay those.

So, I think looking forward, we’ll start to see the housing impact on inflation lessen, meaning it may not be driving the Fed to raise interest rates for longer.

And that is it for me today. I will talk to you all next week!