Inflation Came in Hot, but Rates Went Down?

Hot Inflation, Lower Mortgage Rates

Sometimes the markets will throw you a curveball and act in an unexpected way. This week requires a deeper dive to find out why, after two hotter-than-expected inflation reports, mortgage rates improved. We are definitely not complaining, but it is important to understand the market forces that are driving these rate trends.

Safer Bonds Help Rates Improve

Mortgage rates held very stable at a painfully high level for the last two weeks. That was after the quick worsening that happened through September. This week saw the release of the Consumer Price Index (CPI) and Producer Price Index (PPI) inflation reports. These reports ordinarily would have been very bad for mortgage rates.

Fortunately, other news caused a flight-to-safety trade that led investors to buy bonds, including mortgage-backed securities. This buoyed bond prices and caused rates to improve.

Freddie Mac Survey Misses Late-Week Improvement

One note of caution on what you may read in the news: Freddie Mac’s weekly survey came in unchanged at 7.40% because that survey largely closes before the back half of the week. The daily rate picture tells the real story—Thursday alone brought the largest one-day improvement in eight weeks, and the 10-year Treasury yield has now fallen 21 basis points from its October 5 high.

CoreWeave Debt Concerns Spook Markets

A major player in the AI data center buildout is CoreWeave. Its model is to take on debt, purchase semiconductors and networking hardware, build AI data centers, and sell that capacity to companies like Microsoft and OpenAI. The company is very highly leveraged and utilizes complex collateralized debt structures tied to its GPU purchases. (Does this feel like 2008?)

This leaves the company at risk of default should the markets shift. This has spooked markets and caused investors to pull money out of tech stocks and buy safer bonds.

CPI: Inflation Remains Hot

CPI for September shows a headline increase of 0.6%. This was in line with some estimates but is still a very hot number. Year-over-year inflation rose from 3.4% to 3.7%, with gasoline prices being the biggest contributor after a 9.1% rise during the month.

The core rate, stripping out volatile food and energy prices, rose 0.3%, 0.1 percentage point hotter than estimates. Year-over-year, core CPI rose from 2.4% to 2.6%, while estimates called for an unchanged reading or 2.5%.

PPI: Wholesale Inflation Exceeds Expectations

PPI for September was also hotter than expected. PPI measures wholesale inflation before it is passed along to the consumer and shows up in CPI. The headline rate rose 1.3% for the month, about twice the estimated increase. Year-over-year inflation rose from 5.6% to 6.3%, much higher than the 5.3% expected. Gasoline continues to make up a huge part of that jump.

The core reading, stripping out food, energy, and trade services, rose 0.5%, well above the 0.3% expected. Year-over-year, core PPI rose from 4.8% to 5.0%, more than the 4.4% expected.

Michigan Consumer Sentiment Hits Five-Month Low

Giving markets some bad economic news to digest (but good for rates) was the University of Michigan Consumer Sentiment Index for October. It fell from 48.1 to 46.3, a five-month low that sits below the 1st percentile of the survey’s entire history—lower than the reading at the start of all six recessions since the survey began.

The Current Conditions component did hit an all-time low at 44.7, down from 50.9. Less than 50% of those surveyed expect their incomes to increase over the next 12 months, the smallest percentage ever.

There is a definite split between respondents with assets and those without. Lower-income households with little to no assets have seen confidence drop 25% from the start of the year, while those with higher incomes and assets are only down by high single digits. This supports the premise that the US economy is split, with higher-income earners doing OK while lower-income households really are in pain.

Looking Ahead: A Quieter Economic Calendar

Next week is a quieter news week, and we can hope that the improvement in rates holds and possibly continues.

• Monday, October 19: NAHB Housing Market Index
• Tuesday, October 20: ADP Weekly, Housing Starts and Permits, Pending Home Sales
• Wednesday, October 21: 20-year auction
• Thursday, October 22: Jobless Claims