Investors who fund most mortgages have already priced in several rate cuts, so further declines could depend on what next week’s “dot plot” says about expectations for the pace of future cuts.

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The Federal Reserve is widely expected to start cutting rates next week, and new data that adds some certainty to arguments that the economy is slowing down could make policymakers more inclined start out with a bold move.

Stocks posted broad-based gains this week as investors adjusted to the possibility that the Fed will cut short-term rates by 50 basis-points on Sept. 18, rather than dipping its toe into the water with a more cautious 25-basis point cut. A basis point is one-hundredth of a percentage point.

But investors who fund most mortgages have already priced in several Fed rate cuts this year and next, and whether mortgage rates continue to fall could depend on the release of next week’s “dot plot” showing policymakers’ expectations for the pace of future rate cuts.

The CME FedWatch tool, which tracks futures markets to gauge investor sentiment of future Fed moves, on Friday put the odds of a 50 basis-point cut on Sept. 18 at 45 percent, up from 15 percent on Wednesday.

The shifting bets in futures markets followed Thursday’s release of the Producer Price Index (PPI), which tracks the price of wholesale goods and services, and weekly initial unemployment claims.

Both of Thursday’s data releases supported the thesis that the steady decline in inflation seen in recent months is not transitory — contrary to a surprisingly large increase in prices in August, revealed in the latest Consumer Price Index (CPI) report.

Wednesday’s CPI report showed that core inflation, excluding volatile energy and food prices, was up 3.26 percent from a year ago in August, driven by rising costs for shelter, airline fares, auto insurance, education and apparel.

But the Fed’s preferred gauge of inflation is the personal consumption expenditures (PCE) price index, which registered 2.5 percent annual growth in July — half a percentage point above the Fed’s 2 percent target.

Thursday’s PPI report is having a big impact on markets because it will be used to calculate the August PCE price index, which is scheduled for release on Sept. 27.

Economists at Pantheon Macroeconomics said Friday that they still expect the Fed to cut the federal funds rate by only 25 basis points next week.

But the latest PPI and CPI data points to inflation falling to the Fed’s 2 percent target by the second quarter of 2025, which should enable the Fed to ease more aggressively as unemployment rises, Pantheon economists said Friday in their latest U.S. Economic Monitor.

Jobless claims up slightly

Thursday’s jobs report showed initial jobless claims rose slightly last week, to 230,000, still below July’s average of 240,000.

But economists at Pantheon think the higher level of claims in July “was largely due to disruption caused by Hurricane Beryl and a higher than usual concentration of auto plant shutdowns for retooling.”

In addition, employers created only 142,000 jobs last month, and “employment growth will continue to slow sharply if, as we expect, the combination of tight credit conditions and a slowdown in growth in households’ real expenditure weighs more heavily on hiring,” Pantheon economists predicted.

Mortgage rates fell all summer

Rate-lock data tracked by Optimal Blue shows that since hitting a 2024 high of 7.27 percent on April 25, rates on 30-year fixed-rate conforming mortgages have come down by more than a percentage point. Rates for 30-year conforming loans touched a new 2024 low of 6.10 percent on Wednesday, with borrowers seeking FHA loans locking rates at an average of 5.92 percent.

But whether mortgage rates continue to decline could hinge on the “dot plot” — the Summary of Economic Projections the Fed will publish Thursday revealing how much each member of the Federal Open Market Committee thinks rates should come down in the months ahead.

Futures markets investors are wagering that short-term rates will come down by at least 2.25 percentage points by mid-2025, and investors who fund most mortgages have already priced those expectations into the yields they’ll accept for mortgage-backed securities (MBS).

While Pantheon forecasters expect only a modest rate cut next week, they see the Fed continuing to bring short-term rates down aggressively in the months ahead, by a total of 2.75 percentage points by the middle of next year.

Given that much of the cutting the Fed is expected to do has already been priced into long-term rates, Pantheon expects that yields on 10-year Treasury notes — a reliable indicator of where mortgage rates are headed next — will fall by only 58 basis points over the same period.

Mortgage rates could have more leeway to fall, however, as the “spread” between 10-year Treasury yields and 30-year fixed-rate mortgages continues to narrow as MBS investors become less concerned about prepayment risk.

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