I have blogged a few times over the past couple months about the threat of "stagflation" in today's economy. Stagflation is a period of simultaneous high inflation and high unemployment, not a good scenario.
Whether or not we are headed toward stagflation is debatable. Today's higher unemployment claims report is not a positive sign for the economy or for the prospects of stagflation.
Although the jobs report got the headlines today, the equally important PCE (Personal Consumption Expenditure) report was also released, an important guage of inflation. The results we a concensus 0.2%, for a year-over-year inflation rate of 2.2%. This is a little bit out of the FOMC's comfort zone of 1-2%, but still not unreasonable.
However, when the Fed cuts short term interest rates, it is cause for concern for inflation. Cheaper money can serve to increase inflation, which is bad for long term securities such as fixed mortgage rates. Bond companies must recieve a higher long term rate of return for their investment to compensate for the erosion of the value of that investment caused by inflation. This is the underlying cause of an increase in fixed mortgage rates after an FOMC rate cut.
Most consumers think that a Fed rate cut leads to lower mortgage rates, and I fielded literally dozens of phone calls yesterday from people wanting to lock in a .5% lower fixed mortgage rate. This is one of the most commonly held misconceptions about how the economy works with respect to interest rates and mortgage rates.
Short term mortgage rates, such as adjustable-rate mortgages and home equity loans, which are tied to short term securities, will fall with a Fed rate cut, but long term securities, because of the increased threat of inflation, historically rise after a Fed rate cut.
