The current inflation rate is not worrisome, but is always worth a close look. Any surprise uptick in inflation automatically pushes up mortgage rates. For all of last year, the broad Consumer Price Index (CPI) rose 1.5 percent. As of March this year, the 12-month inflation rate was also 1.5 percent. The more important “core” inflation rate, as it dictates monetary policy, however, is showing signs of accelerating. After removing the volatile food and energy prices from the basket, core inflation increased at a 2.5 percent annualized rate in March, the highest rate in a year. If the core rate rises at such a pace on a sustained basis or moves even higher, then the Federal Reserve will have no choice but to raise interest rates sooner than its public guidance to date. The new chairperson of the Federal Reserve, Janet Yellen, has indicated that the bond-buying program (commonly referred to as the tapering of quantitative easing) is set to end by the close of this year with the first hike in the short-term federal funds rate likely occurring in the summer of 2015.
Why is core inflation suddenly awakening? One key reason is that housing costs have been rising. Apartment rents grew by 2.9 percent. The murkier but nevertheless important figure of homeowner equivalency rent, rose by 2.6 percent, the highest gain in nearly six years! The continuing fall in apartment vacancy rates combined with a general housing shortage assures even higher rent and homeowner equivalency rent for the remainder of the year.
Though home prices have also been rising quite fast, they are not relevant in the CPI calculations. Like stock market valuation, a house is considered an investment asset by government statisticians and not related to the monthly cost-of-living. However, higher home prices will surely infiltrate into higher monthly housing costs in some way. The NAR median home price rose 9 percent in February. The lagging Case-Shiller index showed a 13 percent higher home price in January.
Against the upward pressure on prices coming from housing, there are potential offsets that could keep inflation in check. First, wage increases have been slowly moving up: from 1.5 percent hourly wage gain in 2012 to 2.1 percent in 2013. As of March, the average hourly wage rate of $20.47 for non-supervisory workers, was up 2.3 percent over 12 months. Still rising, but so far this is nothing alarming. The 20-year average annual wage increase is 3.0 percent. There is, in addition, plenty of slack in the current labor market with many underemployed and unemployed who will be willing to work without a wage increase.
Another buffer against inflation is that productivity growth has been rising. Anytime workers produce more in a given time period, then companies do not need to raise prices on goods and services even while paying a bit more to workers to extract profit. Finally, corporate profit levels are at an all-time high. It is the profits along with the loose monetary policy that has fueled the 5-year bull market for stocks. The very high profits mean that higher wages that may arise in the future do not have to get passed on as higher prices on goods, as a slight profit squeeze can easily be absorbed. Had the profit margin been razor thin, then higher wages would immediately register as higher consumer prices.
Let’s not lose sight of what ordinary Americans feel about inflation, either. They care not about core inflation but everything, including what they buy every day at grocery stores and at gas stations. Food prices are already on the rise, clocking in at 5 percent annualized increases in the past two months. Gasoline prices have been lower now versus a year before, but the uptick in crude oil prices hint towards higher gasoline prices this summer. Some public unease over food and gasoline prices, if sustained, will no doubt play into the thinking of Fed policy makers.
All-in-all, inflation looks to rise. For 2014, CPI is expected to rise by 2.7 percent and then move even higher to 3.3 and 3.7 percent by 2015. This inflation forecast is notably higher than the Federal Reserve’s and Wall Street’s. If such inflation does pop out then it will be a surprise. The Fed will quickly signal and then take action much sooner. The 30-year fixed rate mortgage rate is projected to hit 5.5 percent by the summer of next year.
Thank you: RISMedia