What Does CPI Infer About Interest Rates?

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What Does CPI Infer About Interest Rates?

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What Does CPI Infer About Interest Rates?

Welcome to this article where we delve into the latest consumer price index reading for the month of July in the United States and discuss its implications on interest rates. July marked the fourth consecutive month of declines in the consumer price index, increasing by a minimal 0.2% on a month-on-month basis or an annualized rate of 2.9%. These subtle yet significant changes can wield a substantial influence over interest rate policy, something we, as real estate investors, keep a close eye on.

Influence of CPI on Interest Rates and Real Estate Investment

The recent Federal Reserve announcement about short-term fed funds rates remaining stable indicated a need for a continued fight against inflation to build the confidence necessary for a future lowering of interest rates. Analyst predictions for a September rate cut of around half a percentage point (50 basis points) have been circulating. However, for real estate investors, our primary concern regarding interest rate for permanent financing is determined by the yield on US 10-year treasury. For Canadian investors, this rate is indexed to either the five-year or ten-year Canadian mortgage bond.

The Market Forces and Inflation Metrics

The yield on these crucial bonds is determined by the laws of supply and demand in the bond market. Expectations of lower interest rates have prompted a wave of bond investors to move to the 2-year and 10-year denomination bonds. This action increases the price of the bonds a, thus reducing their yield or the interest rate on the investment.

The lower inflation numbers coupled with the higher unemployment rates afford the Federal Reserve the cover it needs to lower interest rates. It’s therefore imperative to understand which component of the economy contributes to these inflation metrics, particularly in areas showing disinflationary territory.

Dissecting the Inflation Metrics and Market Reactions

The imputedOwner’s Equivalent Rent, which is a large part, approximately 40%, of the Core CPI metric has an air of subjectivity and potential for manipulation as it assumes the simultaneous role of landlord and tenant for 65% of the residents in the nation. Regardless of this factor, the recent increase in the Core CPI is majorly driven by the shelter component.

Tenure Yield Rate	Canadian Mortgage Bonds
Down to 3.837%	Down to 3.18% and 3.53%

The bond market’s reaction to the latest CPI data shows a surge in buying for both the two-year and the ten-year bonds leading up to the CPI announcement with an immediate rate increase followed by a sustained downward rate trend.

In conclusion, for real estate investors, all of this is excellent news and presents opportunities for long-term, stable investment.