Vail Daily column: Is inflation ticking up again?
Something that has not been on my radar for quite some time caught my attention last week: Inflation.
The Federal Reserve Board pays close attention to inflationary levels as a key component in their decision to increase or decrease short-term lending rates. With stagnant inflationary levels, the Fed is less likely to increase the short-term lending rate. As inflation increases, the Fed is forced to increase short-term lending rates in order for interest rates to stay ahead of inflationary levels. Longer term interest rates such as mortgage rates rise and fall with inflationary levels as well.
For the Federal Reserve Board, the preferred method or report for measuring inflation is the Personal Consumption Expenditure Index. This report is a major component for interest rates on all fixed rate investments and lending rates. Based on the February readings, that index had its highest inflationary levels in three years.
What Does this Mean
What in the world does all of that mean? Inflation as we are reviewing is the increase or decrease in the costs of goods and services. Simply put, how much you and I pay for anything and everything we buy and consume literally affects and influences the national and global economies. Inflation is an extremely powerful economic factor.
Let’s take a closer look at a mortgage. Once I close a loan, that individual mortgage gets grouped with other similar mortgages into a mortgage-backed security. That security is then sold on the secondary markets. The end investors get paid based upon the interest rate of the particular mortgage. The investor makes no more and no less, which is a fixed rate investment. Whereas, when a stock is purchased, that return on investment fluctuates based upon the stock price.
With any fixed rate investment, rising inflation or the rising costs of goods and services erodes the rate of return of that fixed rate commodity and diminishes its value. In the February readings, the CPE reported inflationary levels of 1.3 percent and core inflation (without gas and food) at 1.7 percent with food and gas factored into the equation. Again, these were the highest reading since February 2013. As or if inflation keeps ticking up from its current levels, then something has to give with fixed rate investments. Higher interest rates on all fixed rate investments, such as mortgages, will increase in suit to keep up with increasing inflationary levels.
When inflation is rising and seen as an imminent threat, secondary investors or buyers of mortgage backed securities want a higher rate of return on the investment before they will buy more securities. Why buy fixed rate investment at say 3.5 percent if inflation is rising and could theoretically be up from the low 1 percent range and closer to the 2 percent range at one point in the near future? The rate of return on the fixed rate is obviously less and less as the costs of goods and services is increasing. When this is the case, the only way to keep the mortgage cycle going and give secondary investors a higher rate of return is to increase mortgage rates at the consumer level.
As I have written about previously, mortgage rates have been more or less immune to rising rates in the midst of other economic influences. Make no mistake about it, if increased inflationary levels are indeed present in today’s economy, then a rise in mortgage rates will occur. The match simply does not add up for the end investors to buy mortgage bonds at today’s rates in the midst of costs for goods and services increasing.
As I have also written about, the mortgage process is extremely complex right now in many regards and advice and guidance from a seasoned professional is the only way to navigate through the process.
William A. DesPortes of Central Rockies Mortgage Corp. can be reached at 970-845-7000, ext. 103, and email@example.com.