Just when you thought inflation may have peaked, consumer prices rose by more than expected last month. After slower growth in April, the consumer price index surged 1.1% in May and was 8.6% higher than a year ago. The annual increase is the highest since December 1981, and above the 8.3% Dow Jones estimate. Core inflation—which removes food and energy costs—rose 6% over the past year and was also higher than expected. The major drivers of inflation in the last 12 months were energy (+34.6%) and food (+10.1%), but every category in the report saw higher prices in May. If you want to see all the data, you can find it in the Labor Department’s release. You might be thinking this isn’t big news, as inflation has been sky-high for a while. That’s true, but after the slight dip in April, many were hoping for better news this morning. The stock market responded quickly to the report, with all three major indexes down sharply this morning. The Federal Reserve will be meeting this week and will most likely hike rates another 0.50%. After that, they will have four more meetings this year—and you can expect hikes after each of them. President Biden recently announced his plan to fight inflation, which you can read here. Both the Federal Reserve and the President have their work cut out for them, but it’s good they are taking strong action to fix this very stubborn problem. So, what does this mean for the economy and housing market? For the economy, the Fed’s rate hikes will present a big challenge, especially since those hikes are specifically designed to slow the economy down. There is even a possibility that we’ll see a brief recession in the first half of 2023. Our knight in shining armor in this battle is the labor market, which is firing on all cylinders right now. Strong hiring, rising wages, and a high savings rate over the past two years have allowed consumers to continue spending, even with the steep rise in prices. Hopefully, they can hang on a while longer, as consumer spending accounts for about 70% of our gross domestic product. For housing, expect rates to keep rising. As I’ve said before, inflation doesn’t have to start declining for 30-year mortgage rates to come down. In fact, rates just fell for three consecutive weeks before last week’s increase. And remember, we may have the highest inflation in 40 years, but mortgage rates are nowhere near a 40-year high. Forty years ago, 30-year rates were over 16%. Below is a chart of the average 30-year fixed mortgage rate, courtesy of the Federal Reserve Bank of St. Louis, or FRED for short.
You can see that we are still in an era of very low mortgage rates. While we would like them lower, this chart reminds us that housing markets can exist and thrive with rates higher than 3%.
So, while the May inflation report was a bad one, the economy and housing market should be strong enough to get through this. Let’s just hope there aren’t too many more bumps in the road.