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Mortgage rates continue to retreat from their 2025 highs as bond market investors who fund most home loans digest new data out Friday showing the inflation is cooling and the economy is slowing.
Concerns about the impact of looming tariffs and a potential trade war also have investors pulling money out of stocks in favor of less risky bets like bonds and mortgage-backed securities.
After moving in the wrong direction for three consecutive months, the Federal Reserve’s preferred measure of inflation, the personal consumption expenditures (PCE) price index, showed annual inflation cooling to 2.5 percent in January, the Bureau of Economic Analysis reported Friday.
The report also showed the biggest drop in consumer spending since February 2021 — leading one model of economic growth to predict the economy is on track to shrink during the first three months of 2025.
Fed’s inflation gauge eases
The core PCE price index, which excludes more volatile food and energy prices, also moved in the right direction, with annual price growth cooling from 2.9 percent in December to 2.6 percent last month.
After hitting a post-pandemic peak of 7.2 percent in June 2022, annual inflation dipped to 2.1 percent in September, allowing the Fed to cut short-term interest rates three times in the final months of 2024.
But mortgage rates and long-term bond yields went in the other direction as the PCE price index started trending back up, hitting 2.6 percent in December. With annual inflation moving away from the Fed’s 2 percent target, the central bank has put further rate cuts on hold.
Friday’s encouraging inflation data had futures market investors pricing in a 78 percent chance that the Fed will start cutting rates again in June, up from 63 percent on Feb. 21, according to the CME FedWatch tool.
Muddying the picture are uncertainties about the Trump administration’s threats to impose tariffs on imports from Canada and Mexico, which are expected to go into effect on March 4.
In addition to raising the price that consumers pay for goods imported from those countries, Canada and Mexico have vowed to retaliate with duties on U.S. goods, which could dent U.S. exports to those countries.
Diane Swonk
KPMG U.S. Chief Economist Diane Swonk said the latest inflation readings are in line with Fed policymakers’ expectations, but don’t reflect the impact of tariffs.
“Our base case is starting to look like tariffs could reach their highest level since 1936,” Swonk said on the social media site X.
“Financial markets are focusing on what is instead of what could be. That can happen during heightened periods of uncertainty,” Swonk said of expectations for rate cuts. “We do not expect any rate cuts in 2025 due to the inflation related to supply shocks. The concern is still more stagflation.”
Stagflation — high inflation coupled with stagnant economic growth and elevated unemployment — hasn’t been seen since the 1970s.
Although the unemployment rate climbed above 4 percent last year for the first time since the pandemic, it had been on the decline in December and January — before the Trump administration began implementing what are expected to be significant cuts to the federal workforce and programs.
In a Feb. 25 analysis, Pantheon Macroeconomics economists Samuel Tombs and Oliver Allen noted that the 2.4 million workers directly employed by the federal government represent only 1.5 percent of total payrolls. But another 7 million workers are employed as federal contractors or have jobs that depend on federal grants.
Pantheon forecasts that the federal government payroll will shrink by 200,000 by October, and that “drag” on the private sector will cost another 100,000 jobs at private companies — “a significant but manageable drag on job growth.”
Samuel Tombs
“The big picture remains that core PCE inflation probably would converge considerably further towards the 2 percent target this year, if Mr. Trump ceased his tariff threats,” Tombs said in a note to clients Friday.
If the U.S. keeps tariffs on imports from China at 10 percent and imposes a 25 percent tariff on all imports from Canada and Mexico, forecasters at Pantheon Macroeconomics expect core PCE inflation “to hover between 2.5 percent and 2.7 percent for the remainder of this year,” Tombs said.
Friday’s Personal Income and Outlays report also showed that consumer spending on goods and services fell by $30.7 billion in January, fueled by pullbacks on spending on motor vehicles and parts, household furnishings, clothing and other goods.
The $76.7 billion pullback in spending on goods was only partially offset by a $46 billion increase in spending on services including housing and utilities.
Those numbers sent the Federal Reserve Bank of Atlanta’s GDPNow model plunging, projecting that the economy will shrink by 1.5 percent in the first three months of 2025.
GDPNow model projects economy is shrinking
Although economists consider two consecutive quarters of negative economic growth to be a recession, GDPNow “is not an official forecast of the Atlanta Fed” but a running estimate of real GDP growth based on modeled data.
Tombs said that January’s plunge in real expenditure “was driven entirely by a pullback in spending on vehicles,” and that private sector data show that auto sales recovered in February.
“Accordingly, we still think that real expenditure is on course for decent quarter-on-quarter annualized growth of about 2-1/2 percent in Q1,” Tombs said.
Shifting investor sentiment about the prospects for continued growth have brought stocks down from last year’s peaks, and long-term interest rates have been pulling back from 2025 peaks since mid-January.
Since hitting an all-time high of 20,204 on Dec. 16, the NASDAQ composite index is down more than 8 percent, closing at 18,544 Thursday.
At 4.22 percent Friday, yields on 10-year Treasurys have come down 60 basis points from a 2025 peak of 4.81 percent on Jan. 14.
Mortgage rates retreat from 2025 peaks
Rates for 30-year fixed-rate mortgages have dropped 40 basis points from a 2025 peak of 7.05 percent registered on Jan. 15, according to rate lock data tracked by Optimal Blue.
When rates were closer to 7 percent in January, the National Association of Realtors’ Pending Home Sales Index (PHSI) dropped 4.6 percent to an all-time low of 70.6.
Lower rates haven’t done much to spur would-be homebuyers into action, but requests to refinance were up 45 percent last week from a year ago, according to a weekly survey of lenders by the Mortgage Bankers Association.
Joel Kan
“Treasury yields moved lower on softer consumer spending data as consumers are feeling somewhat less upbeat about the economy and job market,” MBA Deputy Chief Economist Joel Kan said, in a statement. “This pushed mortgage rates lower, with the 30-year fixed rate decreasing to 6.88 percent, the lowest rate since mid-December.”
Purchase loan applications didn’t increase from the previous week, but were up 3 percent from a year ago.
“Increasing for-sale inventory in some markets has provided prospective buyers more options as we approach the spring homebuying season,” Kan said.
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