May inflation reached a 5% annualized rate, well above the 2% goal, triggering mixed signals on rates from the Fed.
By Manuel Gutierrez, Consulting Economist to NKBA
Officers at the Federal Reserve Bank are sending mixed signals as to near-term directional policy for interest rates. A week ago Benjamin Powell, Chairman of the Fed, stated that the bank would maintain its current policy and not increase rates until 2023 at the earliest. But not long after, Jim Bullard, president of the St. Louis Federal Reserve Bank, indicated that rates would likely increase next year.
During that week, news hit that inflation in May had reached an annualized level of 5%, after several months of increases. This is considerably higher than the Fed’s stated goal of 2%.
Rising inflation has not had a perceptible impact on mortgage rates yet. In the latest reading, the 30-year fixed rate actually fell to 2.93% (Figure 1.) This may change, though, if the Fed alters its policy and begins to push for higher interest rates to curb inflation.
Inflation in May has reached an annualized level of 5%, which may force the Fed to raise interest rates in 2022, rather than 2023, to slow the pace.
Mortgage rates have been quite favorable for home purchasing and remodeling since last summer. They have remained below 3% throughout most of this time, except for a brief period in March and April, when they breached that level.
The low rates continue to encourage consumers to acquire more debt. Figure 2 shows the steady increase in consumer debt for the better part of the past 10 years. Total debt at the end of April was $4.24 trillion, 51% higher than in 2012 for an annual average of 6%.
Last year, however, total outstanding debt fell 2% between January and May, a period when consumers did not take on additional revolving debt, e.g. credit card debt, and at the same time reduced their outstanding credit card balances. At the same time, non-revolving credit taken by consumers continued to increase, rising by 1% during the first five months of 2020.
Over this past year, consumers have resumed their habit of non-revolving credit borrowing, increasing their outstanding balances to $3.27 trillion, up 5% over the last 12 months.
Since January 2020, consumers have increased their total debt by $36 billion as a result of a $164 billion increase in non-revolving credit, while they have reduced their total revolving credit balance by $128 billion over the same period.
A bright consequence of the drop in mortgage rates, besides enabling many consumers to actually become homeowners, is that cost of credit relative to income has improved. This is shown by the monthly consumer debt obligations to their income, the so-called “debt service” ratio.
Figure 3 displays this ratio for total consumer debt as well as mortgage debt. The burden of Mortgage debt has decreased significantly over the last decade. From a peak ratio of 7.2 at the height of the housing boom in 2007, the ratio has fallen steadily to the current level of 4. Although it had dropped dramatically at the most intense point in the pandemic last year, from 4.1 in the first quarter to 3.7 by the second quarter, it has since reversed.
It should be noted that the improvement in the service ratios is a combination of increased income coupled with falling mortgage rates. Per capita income has risen by 67% to $59,210 since 2010, and the fixed mortgage rate has dropped by 1.8 percentage points to the current 2.93%.
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