By Lisa Sturtevant, PhD
Chief Economist, Bright MLS
The positive June inflation report increases the odds that the Federal Reserve will cut interest rates in 2024. The Consumer Price Index (CPI) data released by the U.S. Bureau of Labor Statistics showed that overall prices declined between May and June, the first time prices have fallen since early in the pandemic. The overall June inflation rate was 3.0%, down from 3.3% in May and the third month in a row that this measure of inflation has declined.
All eyes are on the inflation data because inflation is one of the key metrics Fed members are tracking as they make decisions about the timing of cuts to the Federal funds rate. In testimony before Congress this week, the Fed chairman said he sees improvement in the balance between inflation and labor market trends. He also stated that the Fed is looking for evidence that inflation is “moving sustainably” towards 2%.
A common belief was that inflation needed to actually reach that 2% target before the Fed would cut interest rates. However, it is becoming clearer that a durable downward trajectory of the inflation measure—and not necessarily a direct hit of the target—will be enough for the Fed to move on rates this year.
CPI or PCE?
In the alphabet soup of government data, we often hear reports about the CPI, which is published each month by the U.S. Bureau of Labor Statistics and which measures the change over time in the prices paid by U.S. consumers for a range of goods and services. When most people talk about “inflation”, they are referring to the year-over-year change in the CPI.
The Fed actually pays more attention to another measure of price changes—the Personal Consumption Expenditure, or PCE, price index reported by the U.S. Bureau of Economic Analysis. In particular, the Fed watches the PCE price index that excludes the volatile food and energy sectors. There are differences between the CPI and PCE measures but they generally track pretty closely.
Declining Inflation Rates
Regardless of which inflation measure you look at, the increase in consumer prices is down significantly from the peaks in 2022 when the CPI surpassed 8% and the PCE was above 6%. Both measures declined sharply through early 2023. The PCE measure has continued its steady decline, while the CPI measure has bumped around a bit more, but both are definitely trending toward that 2% target. The question is whether the Fed considers this downward trend “sustainable.” To answer that question, they will be watching closely other economic data coming out over the coming weeks.
Rate Cuts Likely on the Way
The decline in inflation, coupled with the Fed's emphasis on progress toward the 2% target, suggests that the Fed will cut the short-term Federal Funds rate, likely at its September meeting. The Fed is meeting later this month, but the chances of a July rate cut are slim, as the members of the Federal Reserve Open Market Committee will want to wait for additional economic data.
Prospective homebuyers have been eagerly waiting for a drop in borrowing costs. Mortgage rates will fall when the Fed cuts interest rates, but it is also possible to see mortgage rates come down even before the actual Fed rate cut, if the central bank assertively telegraphs their intentions.
While a drop in rates is welcome, don’t expect the decline to be significant. The new normal is for rates to remain in the mid-6’s throughout 2024. However, even a modest decline in mortgage rates makes it more affordable for homebuyers to purchase a home. Existing homeowners can also potentially benefit by refinancing their current mortgage at a lower rate.
