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Economy Strong, but Inflation Stays Below Target Rate

May 1, 2019

 

Overview: Over the past week, strong growth data offset tame inflation readings, leaving mortgage rates nearly unchanged heading into Wednesday’s Federal Reserve meeting. The Fed’s post-meeting comments caused a large burst of volatility but resulted in little net movement.

As widely expected, the Fed made no change in the federal funds rate. The statement released following the meeting contained no significant surprises and was modestly favorable for mortgage rates. Of note, officials acknowledged that “market-based measures of inflation remained low” and are “running below 2%” — the Fed’s stated target for the annual rate of core inflation. The tame inflation has persisted despite economic activity and job gains described by Fed officials as “solid."

 

The recently released gross domestic product (GDP) and core Personal Consumption Expenditures (PCE) Price Index reports illustrate the conflicting data between growth and inflation, which has influenced the Fed’s current outlook. First-quarter GDP, the broadest measure of economic growth, increased 3.2%, which was far above the consensus forecast of 2.3% and up from 2.2% growth during the fourth quarter. This was the best reading for a first quarter since 2015, and it occurred despite an estimated 0.3% loss in growth resulting from the government shutdown.

 

In general, stronger economic activity leads to increased demand for goods and services, which typically produces higher inflation. Despite the strength of the economy, however, inflationary pressures have remained surprisingly low in recent months. This puzzling trend was seen in the much lower than expected reading for the broad measure of first quarter inflation released this week. The core PCE price index, the inflation indicator favored by the Fed, was also lower than expected in March, with an annual rate of increase of just 1.6%, down from 1.7% in the prior month.


Week Ahead 

Looking ahead, the key monthly Employment Report will be released Friday. As usual, these figures on the number of jobs, the unemployment rate, and wage inflation will be the most highly anticipated economic data of the month. The Institute for Supply Management (ISM) Services Index also will come out Friday. The Job Openings and Labor Turnover Survey (JOLTS) report will be released May 7. Fed officials value this data to help round out their view of the strength of the labor market. In addition, news about the ongoing trade negotiations between the U.S. and China could affect mortgage rates.

 

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