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Fed Continues to Tighten Policy

Overview: Over the past week, a wide range of events created a great deal of volatility for mortgage markets and pushed rates higher. The major influences were increased tensions between Russia and Ukraine, stronger than expected reports on inflation and consumer spending, and an unexpectedly hawkish (in favor of tighter monetary policy) Fed official. The net result was that mortgage rates climbed to the highest levels in over two years and are more than 100 basis points higher than a year ago at this time.


On Friday, the White House warned that Russia could potentially launch an invasion of Ukraine "any day now." This caused investors to shift from risky assets such as stocks to relatively safer assets such as bonds, including mortgage-backed securities (MBS). The added demand for MBS was favorable for mortgage rates.

The Consumer Price Index (CPI) is a closely watched inflation indicator that looks at price changes for a broad range of goods and services. Core CPI excludes the volatile food and energy components and provides a clearer picture of the longer-term trend. In January, core CPI was 6% higher than a year ago, above the consensus forecast, up from an annual rate of increase of 5.5% last month, and the highest level since 1982. Since inflation erodes the value of future cash flows from bonds, this report was negative for mortgage rates. Due to this strong CPI report on Thursday morning, investors raised their expectations for the pace of Fed tightening this year. Later that day, the Fed’s James Bullard said that he would "like to see 100 basis points in the bag by July 1," which would mean federal funds rate increases totaling a full point over the next three Fed meetings. Investors again raised their outlook for the pace of rate hikes after the comments and now anticipate a 50 basis-point increase instead of a 25 basis-point increase at the next Fed meeting on March 16. Investors also expect the Fed to scale back its bond purchase program more quickly. Since this will reduce demand for MBS, the comments caused mortgage rates to rise.

Consumer spending accounts for over two-thirds of U.S. economic activity, making it an important indicator of the health of the economy. In December, retail sales unexpectedly plunged 2.5% from November, which was far below the consensus forecast. Based on the latest report released this week, however, it appears that the December results did not reflect the longer-term trend. In January, retail sales surged 3.8% from December, far above the consensus forecast for an increase of about half that size. In particular, strength was seen for purchases of vehicles, furniture, and building materials. The bottom line is that the data can be volatile month-to-month, and consumer spending remains quite strong.


Retail Sales (% change)


Week Ahead

Feb. 17 — New Residential Construction report (also known as Housing Starts)

Feb. 18 — Existing-Home Sales report

Feb. 21 — Mortgage markets closed in observance of Presidents’ Day

Feb. 25 — Core Personal Consumption Expenditures (PCE) Price Index


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