Fed on Course to Cut Rates Next Week After As-Expected Inflation Report

Inflation data came in as expected in November, meaning that mortgage rates will stay steady as the Fed remains on course with market expectations to cut rates by 25 bps at their meeting next Wednesday.

November’s core inflation as measured by the CPI, which excludes the volatile food and energy categories, came in at 0.3% from one month ago and 3.3% from a year ago, as forecasters expected. Since hitting a low in June 2024 at 0.1% month over month, core CPI has increased steadily and has been at 0.3% month over month for the past four months. The dynamic behind this trend is that inflation initially fell as goods inflation declined. Economists hoped that services inflation would follow suit, but that has not happened as quickly as expected. Meanwhile, goods prices have started to pick up again though some of the increase is driven by a temporary increase in the price of cars due to October hurricanes. Overall, while this trend is no cause for alarm, it does warrant concern that inflation may get stuck a little above the Fed’s target. And that it may reaccelerate quickly if inflationary policies, such as broad-based tariff increases, are enacted.

Shelter inflation came in at 0.3% month over month in November, continuing its decline and catching up to more forward-looking measures of market rents. Notably, the key categories—rent of primary residence and owners-equivalent rent—both declined to 0.2% month over month in November, with only lodging away from home remaining higher at 0.4% month over month. The three-month annualized rate of overall shelter inflation has declined to 3.8% in November from 5.4% a year ago and 8.3% two years ago. Shelter inflation is the last component keeping overall inflation higher than the Fed’s target. It is a backward-looking measure reflecting economic conditions from years ago, as market rents have been flat for more than two years. However, inflation data in recent months shows that, while bumpy, shelter inflation is in fact coming down as expected. That should make the Fed confident that overall inflation will reach its target, even if it takes longer than expected.

Even though inflation has been a little firmer in recent months, the Fed will follow through with its third consecutive rate cut when it meets next Wednesday, though the cut will have little effect on mortgage rates—as it is already fully priced in. The Fed will also release a new set of projections for 2025. In their last projections, they anticipated four rate cuts of 25 bps each in 2025, but markets are expecting that number to drop to just two rate cuts. Markets are expecting quarterly cuts for the first half of 2025 with a pause in January followed by a March cut and then another pause in May and a cut in June. If inflation does come down to the Fed’s target, those expectations feel conservative as the Fed’s policy rate would remain at 4.0%, above most estimates of the neutral rate. However, fiscal policy is the key unpredictable factor as larger increases in tariffs could justify leaving the Fed’s policy rate higher.

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