Fed Changes Inflation Policy

September 2, 2020

 

Overview: Over the past week, the major economic data and a highly anticipated speech from Federal Reserve Chair Jerome Powell had little lasting impact on mortgage markets. Rates experienced some volatility but ended with little change, remaining close to record-low levels.

One of the hardest hit sectors during the partial shutdown of the economy was manufacturing, but it has seen a very strong rebound over the last few months. The Institute for Supply Management (ISM) Manufacturing Index released this week increased to 56, which was up from a recent low of just 41.5 in April and the highest level since November 2018. Readings above 50 indicate an expansion in the sector.

 

The reduced economic activity resulting from the pandemic has caused a decline in inflation, which has helped keep mortgage rates low. The core Personal Consumption Expenditures (PCE) Price Index is the inflation indicator favored by the Fed. In July, the index was just 1.3% higher than a year ago, up from an annual rate of increase of 1.1% last month but well below the readings close to 2% seen early in the year.

 

On Thursday, Fed Chair Powell outlined a change in policy in which the Fed will be more willing to tolerate higher inflation. The new policy is described as “average inflation targeting,” which means that inflation will be allowed to run above the Fed's 2% goal “for some time” following periods when it has run below that target. It is expected that the Fed now will raise the federal funds rate when labor market conditions improve, at a slower pace than in the past. Although this was a very significant shift in policy, Fed officials had been talking about making a change of this nature for weeks, so its impact on mortgage rates was minimal.

 

Week Ahead

Looking ahead, investors will continue focusing on news about medical advances to fight the pandemic, government stimulus programs, Fed monetary actions, and the pace of reopening the economy. Beyond that, the monthly Employment Report will come out on Friday, and these figures on the number of jobs, the unemployment rate, and wage inflation will be the most highly anticipated economic data of the month. In addition, the ISM Services Index will be released on Thursday.

 

 

ISM Manufacturing Index

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