Mortgage rates rose surprisingly last week after several economic reports showed that the economy was doing better than expected. Now this week, headline inflation data showed prices falling faster than expected. Rates responded with a full rebound despite giving up some of the improvement on Friday after the strong consumer confidence data. If rates could pick just one thing to fear, it would be inflation. Prices depend on the bond. Bonds offer investors a steady cash flow schedule. Over time, inflation can cause cash to buy a lot less “things” than it did to begin with. Investors compensate by demanding higher rates of return, and that’s basically the short version of the post-Covid rate hike. Until this week, the most closely watched measure of inflation had been consolidating in an increasingly narrow sideways pattern, but still at elevated levels. Although it’s only a month’s worth of data, this is the promising breakthrough low-end fans are hoping to see. In one fell swoop, the monthly pace of inflation has returned to its lowest levels since early 2021. Year-over-year inflation also looks good, especially when energy and food prices are factored in (blue line below): The chart above shows the dilemma for policymakers. The Fed sets short-term rates in an effort to constrain the economy and push inflation to an annual pace of 2%. They focus on core inflation (orange line). As you can see in the chart, we’re still very far from 2%, and it’s going to take another year of reports like the ones we just saw before we get back into that range. So the Fed has to decide whether the current level of the federal funds rate is enough to get there with certainty. On that note, the market expects the Fed to hike at least once in two weeks, but after that it will depend more on economic data. Looking at the market’s expectations for the December Fed meeting, we can already see consumer confidence data softening against the positive impact of CPI. Consumer Confidence doesn’t usually compete with CPI when it comes to influencing rates, but this week’s report was very strong. Long-term interest rates such as the 10-year Treasury yield followed a similar path to expectations of a Fed rate hike this week, but they were more interested in inflation data and less sensitive to the “yes-but” provided by consumer confidence data. Equities have also been more focused on the CPI (and its implications for a friendlier Fed…a rising tide tends to help stocks and bonds simultaneously). In the bigger picture, yields are still very much in a holding pattern, but have returned significantly below the 3.84% level that served as a flat ceiling until last week. Speaking of last week, rising prices have led to a higher Freddie Mac mortgage rate index this week, but don’t worry. Freddy takes an average of 5 plus days. In terms of actual daily averages, prices fell sharply over the first four days of the week, avoiding losing too much ground on Friday. Looking ahead, we are in a period of summer lull next week with none of the very important economic reports coming out over the past two weeks. It will also be a “blackout” for the Fed. This refers to the 12 days leading up to the Fed’s announcement where Fed speakers refrain from commenting on policy. As such, the market sometimes guesses a bit more than the Fed thinks, but that’s usually a bigger risk when the blackout coincides with very important data. Either way, this week’s gains are just the beginning. It will take several more weeks – if not months – for economic data to definitively shift price momentum in a friendly direction.