–Expecting mortgage rates to increase
submitted by
Uric Dufrene, Ph.D., Sanders Chair in Business, Indiana University Southeast
Prior to last Friday, markets were pricing in another ½% reduction in the Fed Funds rate. The strong employment report now puts this in doubt. The Fed is now likely to reduce by only a quarter point at their next November meeting. If the next inflation report, as measured by CPI, comes in higher than expected, and if we see another strong employment report next month, we could see the Fed pause additional rate cuts after November.
The Bureau of Labor Statistics reported that payrolls increased by 254,000, far exceeding expectations of 159,000. Private payrolls grew by 223,000, almost double the consensus estimate of 114,000. The labor force saw a pickup of 150,000, but the number of employed expanded by 430,000. This combination resulted in a decline in the unemployment rate from 4.2% to 4.1%.
The reaction in the Treasury bond market was swift, with the 10-Year Treasury yield finishing the day at 3.98%. Just a week ago, the 10-year Treasury yield was 3.75%. With mortgage rates recently closing at 6.14%, the latest round of economic data means that this will likely be a floor for the 30-year mortgage rate. Over the near term, we can expect mortgage rates to move up from the recent 6.15% neighborhood.
The employment report showed that average hourly earnings increased by 4% over the year, higher than the anticipated 3.8%. Recent statements by the Fed indicated that the labor market had moved ahead of inflation as the Fed’s primary emphasis, given that inflation continued the downward trajectory. This higher-than-expected change in average hourly earnings may be the beginning of resurrecting earlier inflation concerns. The next CPI report will be critical and closely watched. A hot report may even shut the door on two rate reductions for the rest of the year.
While the latest employment report was quite favorable, and another indicator of why we are likely not headed for a recession this year, manufacturing continues to remain in a slump. The latest ISM manufacturing index showed another month of contraction, coming in at 47.2, under what was anticipated, and in line with the prior month. Manufacturing has been in a contraction state since 2022, except for one month this past year. The surge in goods spending during and coming out of the pandemic continues to shift with moves toward services. This is one of the reasons for the ongoing manufacturing slump. As a result, regional economies that rely heavily on manufacturing are experiencing unemployment rates that exceed the national average. The near-term outlook is not favorable either, with the ISM report showing that new orders and order backlogs are contracting, in addition to employment and production. The national employment report showed a reduction of manufacturing employment, in the presence of an overall favorable release.
While the goods economy faces challenges, the services side continues to run strong. The latest ISM Services Index increased to 54.9, higher than the expectation and the prior month. Business activity and new orders both came in very strongly, almost hitting 60. This points to continued robust growth in the U.S. economy. Strong growth of the U.S. economy was confirmed with a 3% quarterly growth rate in the second quarter. We should not expect a significant slowdown going into the 3rd quarter.
Data are beginning to point in the direction of an economy that may already be past the slowdown. The keys to watch in the upcoming weeks will be measures of consumer spending, such as retail sales, and inflation. Continued softening of prices will result in additional rate cuts, but any indication of a pause in the disinflation will be met with adverse reactions in the equity markets and an increasing narrative that the Fed’s recent 50 basis cut reduction was a mistake. The markets have already priced in additional cuts, but further strengthening of the labor market, and CPI stubbornness will erode these positions. While disinflation did resume after this year’s first quarter, the economy is still running above the Fed’s desired 2% level. A stronger economy and robust consumer spending will make it difficult to eradicate the inflation dragon, thereby resulting in a pause to rate reductions.
