Inflation is declining, but mortgage rates are not, as investor concerns persist
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- September’s key personal consumption expenditures (PCE) price index fell for the first time since April, in line with expectations and raising the likelihood of a Federal Reserve rate cut on December 10.
- Despite declining inflation, 10-year Treasury yields rose slightly, leading to a three basis point increase in 30-year mortgage rates, reflecting investor caution about the longer-term inflation outlook.
- Pantheon Macroeconomics warns that consumer fundamentals remain challenging and that rates added 0.4 percentage points to annual core inflation in September.
- Mortgage rate forecasts vary: Fannie Mae expects the 30-year fixed rate to be below 6 percent by the end of 2026, while the Mortgage Bankers Association expects an average of 6.4%, underscoring the uncertainty in the home financing outlook.
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Although a Fed rate cut on December 10 is now seen as a lock, investors who finance most home loans are not so optimistic that the central bank will cut rates aggressively in 2026.
A key measure of inflation fell in September in line with expectations, paving the way for a rate cut by the Federal Reserve on December 10. But Friday data release has little impact on mortgage rates, as investors have already priced in three to four Fed rate cuts this year and next as the economy cools.
The Fed’s preferred inflation measure, the Personal Consumption Expenditures (PCE) price index, showed core inflation fell in September for the first time since April.
The CME FedWatch toolwhich tracks futures markets to predict the likelihood of future Fed moves, showed on Friday that investors had priced in an 87 percent chance of a Fed rate cut on Dec. 10, up from 30 percent on Nov. 19.
But yield on government bonds with a term of ten years – a reliable barometer of mortgage rates – rose three basis points on the news as investors weighed the long-term implications of the latest reading of the PCE price index, which was postponed by the government shutdown in October. A basis point is one hundredth of a percentage point.
Lender data maintained by Mortgage News Daily showed interest rates 30-year fixed rate mortgages Increased by the same amount on Friday.
Consumer fundamentals in the coming months “look challenging,” with after-tax incomes rising just 0.4 percent from a year ago due to the weak labor market and the tariff-driven rebound in inflation, analysts at Pantheon Macroeconomics said in a note to clients on Friday. These headwinds “will likely persist both this quarter and next,” they said.
After the Fed cut rates for the second time this year, Fed Chairman Jerome Powell warned on October 29 that a rate cut in December was not a given. But a November 20 report showing unemployment rising to 4.4 percent in September put another rate cut back in the picture this year.
The Fed’s favorite inflation gauge
The PCE core price index, which excludes more volatile food and energy prices, showed annual inflation falling from 2.9 percent in August to 2.82 percent in September.
The main PCE price index, which includes food and energy costs, showed inflation deviated from the Fed’s 2 percent target for the fifth month in a row, reaching 2.78 percent in September.
Annual inflation, as measured by the PCE core price index, peaked at 5.61 percent in September 2022. After falling to a 2025 low of 2.61 percent in April, core inflation started to rise as tariffs introduced by the Trump administration were passed on to consumers.
Consumers currently pay average effective tariffs of 16.8 percent on imported goods, or $1,700 per year for the average household, according to the latest estimates from Yale’s Budget Lab.
The Supreme Court heard oral arguments on November 5 on the legality of the Trump administration’s so-called reciprocal tariffs, and is expects to be able to make a statement this month.
Economists at Pantheon Macroeconomics estimate that inflation in September added about four-tenths of a percentage point to annual core inflation, which would have fallen to 2.4 percent if it were excluded.
“We continue to expect the rate-related boost to inflation to peak [seven-tenths of a percentage point] in March, and ex-rate inflation will continue to decline as wage and rent increases moderate,” Pantheon Macroeconomics economists Samuel Tombs and Oliver Allen said in a note to clients on Friday.
By the end of next year, Pantheon Macroeconomics predicts that core PCE inflation will likely still be “slightly” above 2 percent, but that progress toward the Fed’s target will be enough for policymakers to cut short-term rates by another three-quarters of a percentage point in 2026.
The futures markets, tracked by the CME Fed Watch tool, showed that investors think the latest data has shifted the odds in favor of just two rate cuts next year, a total of half a percentage point.
Since rising to nearly 7 percent in April and May due to rate fears, mortgage rates have gradually fallen, reaching a low in 2025 on Oct. 28, according to lender data tracked by Optimal Blue.
Mortgage interest rates low until almost 2025
As mortgage rates have fallen, they have also benefited from a tightening of interest rates.30-10 spreadbetween mortgages with a fixed rate of 30 years and the interest on government bonds with a term of 10 years.
The 30-10 gap, which averaged less than two percentage points in the decade before the pandemic, rose to three percentage points at times in 2022 and 2023, compounding the pain of rising mortgage rates.
When mortgage rates spiked, investors in mortgage-backed securities, which finance most home loans, demanded higher yields to compensate for the “prepayment risk” that would arise if homeowners refinanced if rates fell again.
Now that mortgage interest rates are falling, the early repayment risk is decreasing. At 2.11 percentage points as of December 3, the 30-10 spread is approaching its historical average – good news for homebuyers.
Forecasters are divided on how much more room mortgage rates should fall.
Mortgage interest rate forecasts vary
Source: Fannie Mae And Association of Mortgage Bankers November 2025 Predictions.
Economists at Fannie Mae predict that interest rates on 30-year loans will fall below 6 percent by the end of next year, but forecasters at the Mortgage Bankers Association expect them to average 6.4 percent by 2026.
The Fed has no direct control over mortgage rates, which are largely determined by demand from MBS investors. After the Fed approved three rate cuts totaling a full percentage point in late 2024, Mortgage rates went up by an equal measure when inflation soared.
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