Inflation alert: It is usually not a good sign when Fed Vice Chairman Richard Clarida said after the consumer price index report “I was surprised”.  I am not sure what rock people are living under, but everything has increased in price from gasoline to restaurant food, appliances, cars, etc… What was in the recent report?  What does this mean for real estate and interest rates?  Should you be alarmed?

What was in the recent consumer price index report?

U.S. consumer prices climbed in April by the most since 2009, topping forecasts and intensifying the already-heated debate about how long inflationary pressures will last.

The consumer price index increased 0.8% from the prior month, reflecting gains in nearly every major category and a sign burgeoning demand is giving companies latitude to pass on higher costs. Excluding the volatile food and energy components, the so-called core CPI rose 0.9% from March, the most since 1982, according to Labor Department data Wednesday. The gain in the overall CPI was twice as much as the highest projection in a Bloomberg survey of economists.

It even caught the federal reserve off guard with the Fed Vice Chairman Richard Clarida said after the consumer price index report “I was surprised”.

 

Why is the CPI so closely watched?

The Consumer Price Index is a tool to measure the impact of prices on the economy.  Basically, there are a basket of goods and services that are tracked to see what is happening to prices.  It is an indicator of inflation/ increases in prices of consumer items from used cars to food, to housing.

What does this mean for longer term treasuries?

The CPI is an indicator of future price pressures for interest rates.  The key rate to watch for long term rates is the 10-year treasury.  The 10-year treasury is a long-dated bond that many rates are pegged off of like mortgage rates.  As the CPI increases, so do longer term rates like the 10-year treasury as investors will demand a higher interest rate as the future return due to inflation will be less

How will this impact mortgage rates?

As 10-year treasuries rise so do mortgage interest rates.  We have already seen a steady rise in rates as the economy has opened back up, look for rates to soon make another jump as the market digests the higher inflation.

What does this mean for real estate?

Interest rates will be the catalyst that finally slows the markets.  With the trajectory of inflation and threat of further stimulus, 10-year treasuries and in turn mortgage rates have a long way to go higher.  As mortgage rates rise, the relative price of a house increases substantially.  With house prices already at lofty levels, wages are not coming even close to keeping up with the increased payments.  The largest driver of the latest real estate cycle has been ultra-low interest rates. When this spigot turns off, which it will because of huge jumps in the CPI, the real estate market will come to a screeching halt.

Summary

I have mentioned many times in my posts that the government was playing a dangerous game with the huge amount of stimulus.  The CPI number confirms these fears. All the stimulus and loose monetary policy is now causing the economy to overheat through rising prices.

Ironically, there is currently talk in Congress for even more stimulus via an infrastructure plan.  Unfortunately, the infrastructure proposal will throw even more gasoline onto the already roaring economy.  The economy will continue to get hotter until the spigots of rock bottom low rates along with huge fiscal stimulus subside.   I tell my kids when we run together to make sure you pace yourself; the federal government needs to heed this advice as we are entering a phase of too much of a good thing that will cause rampant inflation and serious unintended consequences for the economy. Average Americans already know this as consumer sentiment unexpectedly declined this week due to fear of inflation.  Hopefully, our politicians will wake up and smell the coffee before it is too late.

 

 

Additional Reading

 

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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending.  Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine,  The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.

 

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