Jan 092018

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By G. Steven Bray

Mortgage rates have bounced up slightly since passage of the tax reform bill. While it’s not clear this was the cause, it’s evident tax reform has boosted sentiment as evidenced in the soaring stock market indices. What does that mean for rates going forward?

If tax reform was the only thing on market investors’ minds, it’s likely we wouldn’t be talking about a slight increase in rates. Notice that short-term interest rates have risen much more than long-term rates, resulting in a flattening Treasury yield curve. Something is keeping a lid on longer-term rates.

I suspect that something is inflation, which continues to post numbers below the Federal Reserve target of 2%. Markets watch several inflation measures, and all have been tame. The Fed’s favored measure, the PCE, remained at 1.5% last month. Wage inflation, as reported in last week’s jobs report, hit expectations at 2.5% after a downward revision to the previous month’s number. Consumer expectations for inflation remain historically low.

This week, we get what is probably the market’s favorite measure, the Consumer Price Index. While it has quirks that make it less valued by the Fed, it has great historical significance. The core CPI dropped back below 2% about a year ago and has been without a pulse since then. Should Friday’s report show that inflation ticked up, even by a modest amount, I expect rates to bounce higher again. If inflation remains dead, the bond market probably will continue to drift, looking for some other source of inspiration.

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