According to MBS Highway, the Consumer Price Index (CPI) was reported last Friday and it showed that consumer inflation rose 1% in May, which was much higher than the expected 0.7% gain. On an annual basis, CPI rose from 8.3% to 8.6%, which is the hottest reading in 41 years!

Of particular note within the report, food costs climbed another 1.2% in May, bringing the year-over-year gain to 10.1%. Rents rose 0.6% last month and are now up 5.2% year over year. Fuel also increased 16.9% in May and is now up almost 107% from this time last year. On average across the country, gas prices are over $5 a gallon, which is the highest ever.

Rising Inflation

Rising inflation is significant, and not just because it leads to higher costs of goods. Inflation is also the arch enemy of fixed investments like Mortgage Bonds because it erodes the buying power of a Bond’s fixed rate of return. If inflation is rising, investors demand a higher rate of return to combat the faster pace of erosion due to inflation, causing interest rates to rise, as we’ve seen this year.

The Fed has been under pressure to address rising inflation and the main tool the Fed uses to curb inflation is hiking its benchmark Fed Funds Rate. This is the interest rate for overnight borrowing for banks and it is not the same as mortgage rates. Counterintuitively, when the Fed hikes its benchmark Fed Funds Rate, this can be good for interest rates because it curbs inflation.

Fed Actions

The Fed was expected to hike its benchmark Fed Funds Rate by 50 basis points at its meeting this week, but instead acted more aggressively with a 75 basis point hike, due in large part to the hotter than expected CPI reading. The Fed also noted that depending on the data, they will hike another 50 or 75 basis points at their meeting on July 26-27.

In addition, the Fed’s dot plot chart shows the Fed Funds Rate at 3.4% at end of this year, which means hiking another 175 basis points over the remaining four meetings. This could potentially mean hikes of 75 basis points in July, 50 basis points in September, 25 basis points in November and 25 basis points in December, or some combination thereof.

Forecast Moving Forward

The Fed also noted that they see the unemployment rate only going up 0.1% this year to 3.7%, however the Fed is undergoing the most aggressive hiking cycle in 40 years. The Fed also expects 1.7% growth this year, but GDP was -1.5% in the first quarter and the Atlanta Fed just adjusted their forecast for GDP for the second quarter to 0%.

The key takeaway is that central bankers around the world are scrambling to put the inflation genie back in the bottle, as we have seen hikes by the Bank of England, Taiwan, United Arab Emirates, Qatar, Bahrain, Brazil and a surprise 50 basis point hike by the Swiss Bank, which led to market volatility this morning.

It will be important to see if investors and the markets believe the Fed and other central banks can get a handle on inflation, as this will play a crucial role in the direction of Mortgage Bonds and mortgage rates this year.