Inflation Is Cooling and Consumers Are Slowing — So Why Aren't Mortgage Rates Falling Faster?

Mortgage markets received several encouraging economic reports this week.

Inflation is showing signs of cooling.

Employment is weakening.

Wage growth has slowed.

And now consumers appear to be pulling back.

Normally, that combination would be exactly what mortgage borrowers want to see.

So why aren't mortgage rates falling dramatically?

The answer is that today's mortgage market is being influenced by two very different forces.

## Inflation Continues to Moderate

July's Producer Price Index was unchanged month-over-month, below expectations for a 0.1% increase.

Core PPI also came in softer than expected.

That followed a Consumer Price Index report that contained additional signs that year-over-year inflation is moderating.

Inflation remains above the Federal Reserve's long-term target, but the direction matters.

If inflation continues moving lower, the Fed has less reason to consider another rate increase.

## The Labor Market Is Weakening

July's employment report was considerably softer than expected.

Payrolls declined by 23,000 jobs.

Previous months were revised lower by a combined 103,000 jobs.

Wage growth slowed to approximately 3.15% year-over-year, and labor-force participation declined to 61.4%.

That matters because a strong labor market was one of the reasons the Fed could remain aggressive toward inflation.

A weakening labor market changes that calculation.

## Now the Consumer Is Showing Weakness

July Retail Sales fell 0.6%.

Even after accounting for volatile categories such as gasoline and autos, spending was weaker than economists expected.

Online sales also declined.

There are some timing issues in that data because Amazon Prime Day occurred in June rather than July this year, but even looking across multiple months, online spending has softened.

At the same time, the household savings rate is around 2.7%, one of the lowest levels historically.

Consumers haven't completely stopped spending, but there are increasing signs that household finances are being stretched.

## Why Isn't This Sending Mortgage Rates Lower?

This is where today's market gets interesting.

The Federal Reserve primarily controls short-term interest rates.

Mortgage rates, however, are much more closely connected to longer-term bond yields.

And the U.S. government is borrowing an enormous amount of money.

This week, the Treasury sold $25 billion of 30-year bonds at a yield of approximately 5.22%.

That was the highest financing cost for a 30-year Treasury auction since 2001.

The 10-year Treasury auction also produced its highest financing cost since 2007.

Investors are essentially demanding greater compensation to lend money to the federal government for long periods.

That creates a tug-of-war.

Softer inflation and economic data are pulling rates down.

Government borrowing and Treasury supply are pushing longer-term yields up.

Mortgage rates are caught in the middle.

## There's Another Story Developing in Mortgage Lending

Traditional conventional financing isn't the only market expanding.

Non-QM lending has become an increasingly important option for financially strong borrowers whose income doesn't fit neatly inside traditional underwriting guidelines.

That can include:

* Self-employed borrowers

* Business owners

* Real estate investors

* Borrowers using bank statements to document income

* DSCR investment-property borrowers

* Clients with complicated tax returns

These aren't necessarily borrowers with poor credit.

Often, they're financially successful people whose tax returns don't tell the whole story.

There are also more options for homeowners with substantial equity.

Someone who already has a low-rate first mortgage may not want to refinance the entire balance simply to access cash.

A HELOC or closed-end second mortgage may allow that homeowner to tap equity while leaving the existing first mortgage untouched.

What Happens From Here?

Mortgage bonds are currently holding onto gains from the past several days.

The technical picture has improved, but bonds remain in a fairly wide trading range, which means volatility can continue.

Next week's calendar includes Housing Starts and Building Permits, Pending Home Sales, Federal Reserve meeting minutes and weekly employment data.

For mortgage rates, however, the larger story is becoming clearer.

Inflation is moving in the right direction.

Employment is weakening.

Consumer spending may be slowing.

Those developments should eventually be supportive of mortgage rates.

The question is whether pressure from government borrowing and long-term Treasury yields prevents rates from falling as much as borrowers might otherwise expect.

For buyers, that means waiting for the "perfect" rate may still be the wrong strategy.

Instead, understand the payment, negotiate aggressively, structure the financing correctly and be prepared to take advantage if the rate market gives us an opportunity later.