Takeaway: Mortgage rates are unlikely to move after a mild inflation report still marred by government shutdown-related distortions. Looking through the statistical issues, inflation likely remains as expected, keeping the Fed on hold for the foreseeable future.
Inflation was slightly lower than expected in December in today’s CPI report. The numbers are still skewed by the government shutdown, but underlying inflation is unlikely to be a major cause for concern.
- After stripping out the volatile food and energy categories that Fed officials care less about, core prices increased 0.24% from a month ago and 2.6% from a year ago in December. Forecasters had expected 0.36% and 2.8%.
- After the government shutdown ended, the November CPI report was distorted by a number of factors that caused the reported numbers to be too low. Many of those issues resolved themselves with today’s report. But one remaining issue is that shelter inflation–that is, rent inflation–is still too low.
- Rent, over 40% of core CPI, is sampled in six groups, with only one surveyed monthly. For the group due for fresh data in October, the Bureau of Labor Statistics (BLS) assumed zero inflation. This assumption is likely too low, as rental CPI inflation hasn’t been zero since the financial crisis. This zero-inflation assumption will persist for this group until next April, artificially suppressing inflation until then.
- Looking through the statistical issues, the “excess” inflation above where the Fed would like inflation to be is almost all in goods inflation rather than services. This inflation is primarily driven by tariffs, which means that it will come down later in 2026 once the higher price levels have been fully baked in. That also implies that underlying inflation, apart from tariff effects, is largely fine so there is little need to worry about the Fed hiking rates.
The Fed will remain on hold and mortgage rates are unlikely to budge much for the foreseeable future.
- The Fed is much more focused on labor market data and any signs of increasing recession risk that would warrant faster rate cuts.
- Much of the attention right now in financial markets is on Fed independence given the news of a criminal investigation into Chairman Powell.
